7 - Employment And Inflation , Introduction

Question 1

What’s the relationship between price and output

Answer 1

Negative relationship - Higher price, output will decrease

Question 2

What is aggregate demand (AD)

Answer 2

Consumption + investment + government expenditure + (exports - imports)

• AD captures the effect of the price level on output

Question 3

Why does AD curve slope down (why does demand decrease when price increases)

3 effects

Answer 3

1) Income effect = As prices rises, wages may not keep up - more money goes as profits so people have less to spend (less purchasing power)

2) Substitution effect = Higher domestic prices lead to fall in domestic demand for UK produced goods and a rise in demand for imports

3) Real balance effect = As prices rise, real value of savings fall, so people might cut back spending to preserve real value of saving

Question 4

What is a shift in AD caused by

Answer 4

• Fiscal Policy (Government intervention like, tax reduction, tax increases, increased government spending (expansionary), reduces government pay or jobs (contractionary)
• Monetary Policy (Increased interest rates, printing money)
• Wage

Question 5

What does AD look like on a graph

Answer 5

• Price level on Y axis
• Output on X axis
• AD curve, curves down (not a straight diagonal line)

Question 6

What makes AD shift left or right

Answer 6

Left = Decrease in nominal money (increase taxes)

Right = Increase In Government spending, Increase consumption

Question 7

Describe AS graph

Answer 7

• Y axis = Price level
• X axis = Output (Y)
• AS Curve, curves upwards as there’s a positive relationship between P and Y, as price increases output increases

Question 8

Why does AS curve slope upwards

Answer 8

If we assume resource (input) costs are stable or constant then at higher price firms profitability will increase, so firms are encouraged to produce more

Question 9

3 factors that cause AS curve to shift upwards

Answer 9

• Commodity prices = Higher raw material costs, less profit, shift AS curve up
• Nominal wages = Higher wages, high labour costs, less profit, shift AS curve up
• Productivity = Decrease In productivity, decrease in education level, shift AS curve up

All vice versa if opposite happens, (increase profit, AS curve shifts downwards)

Question 10

What’s the one thing that doesn’t shift AD curve

Answer 10

Price, it stay on the same curve, output would change though

Question 11

Equilibrium in short run aggregate supply

Answer 11

Normal supply and demand graph (equilibrium stable in the short run)

Question 12

Long run aggregate supply

Answer 12

• Y axis = Price level
• X axis = Output
• Vertical line, as there’s full employment, it’s at potential output (if price increases, output could not change as we have used all available resources)
• LRAS can shift to the right if there’s economic growth, by increasing economically active people (reduce NRU) or can spend money on training to increase productivity

Question 13

What is potential output

Answer 13

Amount of goods and services an economy can produce when both labour and capital are fully employed (use all capital and labour)

• Called potential output and not maximum, because it doesn’t include economically inactive people, only available resources

Question 14

What’s the 2 economic issues facing policy makers

Answer 14

Inflation and unemployment

Question 15

4 ways to measure inflation

Answer 15

• Consumer price index (CPI) = Depicts changes in prices of a market basket of consumer goods and services purchased in a household
• Producer price index (PPI) = Weighted index of prices measured at the wholesale, or produced level
• GDP deflator = (Nominal GDP / Real GDP) x 100
• Core price index = Measures prices paid by consumers for goods and services excluding certain products. E.g. food and energy that face volatile price movements, to reveal underlying inflation trends

Question 16

What does expansionary policy do
What does contractionary policy do

Answer 16

Expansionary Policy = Increase inflation, reduce unemployment

Contractionary Policy = Decrease inflation, increase unemployment

Question 17

What’s deflation

Answer 17

Opposite of inflation (decrease in general price levels throughout the economy

Question 18

What’s disinflation

Answer 18

Fall of inflation rate

Question 19

Difference between deflation and disinflation

Answer 19

Deflation refers to decrease in general price level whilst disinflation refers to decrease in inflation rate

• E.g. General price is 100 in 2010, 110 in 2011, 115 in 2012 and 90 in 2013. So inflation in 2011, disinflation in 2012 and deflation in 2013

Question 20

What’s Unemployment

Answer 20

The unemployed are individuals of working age who are capable of work, and are actively looking for work, but who are not employed

Question 21

What’s frictional unemployment

Answer 21

Unemployment occurring because people are moving or changing occupations. E.g. when people switch jobs

Question 22

What’s structural unemployment

Answer 22

Unemployment arising from changes in composition of output due to variations in types of products people demand

E.g. Factory shutting, have to find job somewhere else where different skill set is required

Question 23

What’s natural rate of unemployment (NRU)

Answer 23

Level of unemployment when the economy is at full employment level.

• NRU is a combination of frictional and structural unemployment

Question 24

What’s cyclical unemployment

Answer 24

Unemployment relating to business cycle.

When business cycles are at their peak, cyclical unemployment will be low because total economic output is being maximised. When economic output is low, business cycle is low, cyclical unemployment will rise