ch11 flashcards
describe the difference between short run and long run economic growth
- short run economic growth is bringing idle resources into production and takes up slack in the economy
- long run economic growth is shown by an outward shift of the economy’s PPF, increasing the economy’s productive potential
AD formula
AD = C + I + G + (X - M)
what are some things that can shift the SRAS curve to the right for firms
- fall in money wage rates
- fall in costs of production
- fall in taxes on firms
- increase in subsidies on firms
what is the economy’s trend growth rate
the rate at which output can grow sustained without putting upward/downward pressure on inflation
what are causes of long run economic growth
- improvements in technology resulting from investment and technical progress
- increases in size of the labour force
- improvements in productivity, attitudes and enterprise
- mobility increase of factors of production and economic incentives faced by entrepeneurs and the workers they employ
name the two economic growth theories
neoclassical growth theory
new growth theory
describe the neoclassical growth theory
- argues that a sustained increase in investment increases the economy’s growth rate, but only temporarily
- the rate of capital to labour goes up, the marginal product of capital declines and the economy moves back to a long-term path, determined by output growing at the same rate as the workforce
- the rate that labour productivity improves is determines by the technological progress, which is the weakness: the cause of growth is outside of the theory so there is no explanation of why economic growth occurs
describe the difference between the neoclassical and new growth theory
- unlike neoclassical, the determinants of technological progress are brought into the model
describe the new growth theory
- profit seeking research - the rate at which technological progress occurs depends on the stock of ideas. new ideas by new research is added to the capital stock of ideas
- it is assumed that having more researchers means countries have higher growth rates
- economic growth can derive either from domestic innovation or from technological transfer from other countries
- human capital accumulates through educating and training a workforce and through migration, a high level of human capital is necessary but not sufficient for successful economic growth,
- a technological change requires workers to possess the skills for adapting to new technologies rather than those that used to be necessary for old, declining technologies
- new growth theory suggests that appropriate government intervention can create the supply side contitions (encouraging research, externalities, incentives for firms to innovate)
what are the costs of economic growth
- uses up finite resources such as oil that cannot be replaced
- leads to pollution and other forms of environmental degredation
- can destroy local cultures and communities, widening inequality
- leads to urbanisation and rapid growth, taking agricultural land
- countries suffering low growth can get into a negative cycle
what are the benefits of economic growth
- increases standard of living
- leads to communities that improve the environment
- provides new technology which can help environment
- provides a route out of poverty
- generates positive cycle of growth for benefiting countries
draw a graph showing the economic cycle
graph 11.6 on flashcards
what is a recovery
when GDP begins to grow after the end of a recession
- recovery gives weigh to the boom
what is a boom
level of real output becomes greater than the trend level of output
- ends when the upswing gives way to the downswing
what are the 7 causes of change in economic cycle phases
- fluctuations in AD/AS
- role of speculative bubbles
- outside shocks
- political business cycle theory
- marxist theory
- multiplier/accelerator interaction
- climate cycles
describe how fluctuations in AD/AS cause change in economic cycle phases
- Keynes argues that recessions are caused by fluctuations in AD which are caused by consumer and business confidence
- Prescott and Kydland argue that changes in technology might be as important as AD changes
describe how the role of speculative bubbles cause change in economic cycle phases
- rapid economic growth leads to rise in speculative bubbles which arew when people realise that house and share prices have risen above the asset’s real value so people sell, causing the bubble to burst, destroying consumer confidence, as people stop spending and recession occurs
- the result is cyclical instability
describe how political business cycle theory causes change in economic cycle phases
- in democratic countries, general elections take place every 4/5 years.
- as it approaches, a political party tries to influence people by engineering a boom
- after the election, the party in power deflates AD to prevent the economy from overheating until the next election approaches
describe how outside shocks hitting the economy cause change in economic cycle phases
- e.g. a war in the middle east leads to an oil shortage which increases business costs of production (this is a supply shock)
describe how changes in inventories cause change in economic cycle phases
- as well as capital, firms also invest in stocks (inventories) of raw materials and finished goods waiting to be sold (stock building)
- these stocks build up when firms overestimate demand, so they accumulate and firms are forced so stop production, causing a recession
describe how the marxist theory suggests how change in economic cycle phases are caused
- marxists believe recessions create conditions in which stronger firms either take over weaker competitors or buy assets of firms that have gone of business
- in marxist theory economic cycles are deemed necessary for the regeneration and survival of capitalism
describe how multiplier/accelerator interaction cause change in economic cycle phases
- Keynesian economists have argued that business cycles are caused by interaction of of multiplier process (increased investment leads to increases in national income) and the accelerator (increase in income causes change in investment)
- the relationship between investment and income is mutual-investment affects income which affects investment demand-income and employment fluctuate in a cyclical manner
describe how climatic cycles cause change in economic cycle phases
- Stanley Jevons recognised the economic cycle, believing there was a connection between the timing of economic crises and the solar cycle
- variations in sunspots affect the power of the sun’s rays, influencing quality of harvests and price of grain, affecting business confidence
what are the indicators used to identify economic cycle phases
- usually GDP, but also rate of inflation, investment and unemployment can influence the economic cycle phases
- employment increases and unemployment decreases in the recovery and boom plases
what is an output gap
shows the level of actual real output in the economy, either higher/lower than the trend output
describe positive and negative output gaps
the level of actual real output is greater than the trend output level
vice versa for negative output gap
when do positive output gaps occur
when the economy temporarily produces at a point outside its current PPF
describe output gaps in the UK economy
in 2000-2008, there was a positive output gap and a booming economy
- this stopped in 2008/9 in the recession
- in the recovery, the negative output gap gradually became smaller until 2018, but this doesn’t indicate a return of a boom
what is the difference between voluntary and involuntary unemployment?
- voluntary is when workers choose to remain unemployed and refuse job offers at current market wage rates
- involuntaryis when workers are willing to work at current market wage rates but there are no jobs available
what did Keynes argue relating to AD and unemployment
in the 1930s, during the great depression, Keynes argued that low AD results in involuntary unemployment
what is frictional unemployment and describe it’s two causes
frictional unemployment is when there are delays in the labour market when a worker is unemployed when moving from one job to another (this definition assumes that a job vacancy exists and that the friction, caused by the immobility of labour, prevents an unemployed worker from filling the vacancy.
- GEOGRAPHICAL immobility of labour is caused by factors such as family ties and local friendships discouraging people from moving to other parts of the country
- OCCUPATIONAL immobility of labour results from difficulties in training for jobs that require different skills. (restrictive practices such as discrimination in labour markets or unnecessary requirements)
what is structural employment and what does it result from
- results from the structural decline of industries which are unable to adapt to changing demand/new products
- there are changing skill requirements from industries changing the way they make their products, which the labour force are unable to adapt to so they can’t find a job
Why has structural unemployment grown in the UK service sector?
- partly caused by the increasing use of information and communication technology and automated services
- call centre employment has grown significantly though have moved overseas to lower-waged countries such as India
- some companies which used to employ call-centre workers now use automated communication software rather than humans to provide customer services
Describe how structural unemployment has affected the UK since 1945
- from the 1950s to the 1970s, structural unemployment was concentrated in regions where 19th century staple industries such as textiles and shipbuilding were suffering structural decline
- this unemployment from the decline of industries was more than the growth of employment in growing industries
- in the 1980 and 2008 recessions, SE affected almost everywhere in the UK as deindustrialisation process spread - decline in manufacturing industries as a result of international competition
what is cyclical unemployment and when does it occur
- in contrast to frictional unemployment, he believed cyclical unemployment is involuntary not caused by the workers themselves
- occurs when there is a lack of AD in the economy, occuring when the economy goes into a recession or depression
what is seasonal unemployment and when does seasonal unemployment occur
- when casual unemployment results from regular fluctuations in weather conditions or demand
- occurs when workers are laid off on a short term basis at certain times of the year (e.g. tourism in the summer)
describe the real wage theory of unemployment
- much of the UK’s unemployment in the 1920s resulted from the lack of competitiveness and decline in standard industries
- free market economists blamed this on excessively high real wages (real wage unemployment)
in terms of graph 15 with blue pen, describe the graph and about wage rates and emploument (free market economists and pre-keynsian free market economists)
- full employment is shown at X where AS of labour meets AD of labour
- however if wage rates are at w1 not WFE, employers wish to higher e1 workers but e2 want to supply their labour, so there is excess supply of labour between Z-W
- free market economists argue that as long as labour markets remain competitive, the resulting real-wage unemployment should be temporary
- competitive forces in the labour market should cure the problem, keeping the real wage rate to WFE, eliminating the excess supply of labour
- full employment should then be restored when the number of workers willing to work = number of ppl firms wish to hire
- pre keynsian free market economists blamed trade unions for the mass unemployment that occured between WW1 and WW2
- they believed the responsibility for unemployment was with workers in work and their trade unions who prevented the unemployed from pricing themselves into jobs by refusing to accept lower wages
- many keynesian economists believe real-wage unemployment to be involuntary caused by wage inflexibility for which the workers have no control
- but the free market economists argue that it is voluntary as trade unions should be prepared to accept wage cuts
what are the consequences of unemployment on the economy
- not all productive resources are used, operating inside the PPF
- reduces the economy’s international competitiveness as unemployment reduces incentives for firms to invest in technology . Underinvestment can also be caused by the higher business taxes that firms may have to pay to help fund benefits for the unemployed
- economies are badly affected as a worker becomes increasing unemployable the longer they’re unemployed
what are the consequences of unemployment for indivuals
- unemployment leads to lower standards of living as families suffer increased health risks, stress etc
what are some gov policies to reduce unemployment
- reducing frictional and structural unemployment by improving geographical and occupational mobility of labour by reducing workers’ search periods between jobs and introducting SS policies
difference between inflation and deflation
- inflation is the continuous rise in the price level or a continuing fall in the value of money
- deflation is the tendency for the price level to fall or for the value of money to rise
describe the history of inflation
1970s - inflation was accelerating and was highly variable so control of inflation was a policy in 1980
- From 1993-2007 it stayed around 1% away from the 2% limit set, apart from a few occasions
- until 2008 the control of inflation was accompanied by a long period of economic growth until huge cost-push inflation in 2007 and problems in financial markets in 2008
- inflation from 2012 remained close to 2%
- inflation began to rise in 2021 linked to the rise in price of domestic heating, petrol and food, problems caused by covid and ukraine war
- 2022 stagflation - high inflation with stagnant economic growth
what does a deflationary policy include
it uses fiscal/monetary policy to reduce AD to take excess demand out of the system and the rate of inflation falls
what is disinflation
the rate of inflation falls but remains positive
what is demand pull inflation
caused by the increase of AD
- if the economy is initially producing on the SRAS curve. but below normal capacity level out output (LRAS), price level has to rise to persuade firms to produce more output to meet extra demand
- this is when firms suffer from higher costs when they produce more goods. for firms to maximise profits, higher prices are needed to reward firms for producing more output, once the LRAS curve is reaches, higher prices can temporarily encourage firms to produce beyond this point but the increase in output cannot be sustained
what is cost push inflation
during the Keynsian era in the 1960s and 70s, the rate of inflation increased even when there was little evidence of excess demand in the economy, which led to the theory of cost-push inflation
- SRAS shifts left as production costs rise and the economy shifts left
- this causes prices to rise because demand stays the same but supply decreases
- so the economy slows
what is the theory of monetarism
the theory that inflation is caused by an increase in the money supply
what is the quantity theory of money
the oldest theory of inflation which states that inflation is caused by a persistent increase in the supply of new money
equation of exchange
money supply x velocity of circulation of money = price level x quantity of output
why do Keynsian economists reject the quantity theory as an explanation of inflation
The velocity of circulation isn’t constant
- monetarists believe people don’t hold idle money however Keynsians think the opposite, and believe when share prices are about to fall, people hold idle money to avoid capital losses
Under full-employment equilibrium
- Keynsians say if there is spare capacity in the economy (and unemployment) an increase in the money supply may increase real income and output rather than PL
- market forces are too weak and take too long to return the capacity to normal, which means the economy can get stuck in the under-full employment equilibriium
reverse causation (instead of changes in supply of money causing PL change, inflation is fue to cost push factors (swapped places)).
instead, the increase in money supply may be absorbed and slow down velocity.
the role of expectations in the inflationary process
- if people expect the rate of inflation next year is going to be high, they will behave in an inflationary way now, with trade unions and workers bargaining for higher wages
- when people expect inflation to fall, they behave in a way that enables low inflation to be achieved
describe the two types of inflation psychology
adaptive expectations
- when people from their beliefs of future events based on past event
rational expectations
- people form their expectations using all available information tht exists to support decision making
free market economists ideas about rational expectations
free market economists believe that it is unrealistic to assume that a rational economic agent forms future expectations solely based on the past- self interest requires people to know up to date info
consequences of inflation
distributional effects - groups in society living onfixed incomes lose as their wages won’t rise in line with inflation
distortion of normal economic behaviour - households may bring forward purchases and hoard goods if they think inflation will rise, and firms may take funds out of investment into hoarding
breakdowns in functions of money - money becomes less efficient as a medium of exchange .In the most extreme form of inflation, less efficient barter replaces money and imposes extra costs on most transactions
reduced international competitiveness - when inflation is higher than in other competitor countries, exports increase in price, putting pressure on a fixed exchange rate, from which lower growth and rising unemployment results
consequences of deflation
- when people believe prices arre going to fall, they postpone their big spends like cards, which erodes business confidence and trigger recession/deepen current recession
examples of good and bad deflation
good - reduced business costs, output and employment rises
bad - Ad shifts left as people postpone their prices
how do changes in other countries affect UK inflation
- when the world economy is doing well with rising demand and rising prices, the UK tends to import this inflation from booming economies abroad
- if prices of imported food and raw materials increase, it leads the UK to suffer import cost-inflation
- when the world economy is doing badly, with other countries experiencing recession, pressure on UK is reduced, falling demand worldwide for UK exports and left shift of AD could lead to damage to the UK
which two countries are significant in how they affect UK prices and why
USA and china
- USA is a source of demand for exports inward investment and business and consumer confidence for the UK
- british consumers benefited from falling prices of manufactured goods imported from China, reducing UK’s inflation rate
- costs of production in china has risen so the prices of manufactured goods imported from China has increased, increasing retail prices in UK but only mildly
- outside shocks include middle east oil can increase UK inflation if prices go up
what are the 4 conflicting objectives between macroeconomic policy
- full employment/satisfactory balance of payments
- low unemployment/control inflation
- increase rate of economic growth/achieve equal distribution of wealth and income
- higher living standards now/in the future
what are the free market economists’ views on conflicting policy 3
- by taxing the rich more and transferring this revenue to the poor the UK government have tried to reduce income inequalities
- however free market economists argue that such policies reduce entrepeneurial incentives, making the economy less competitive and growth rate slowr
- their view is that inequalities are necessary to promote conditions for rapid and sustainable economic growth
views on conflicting policy 4 (higher living standards now or in the future)
- in the short term the way to do this is by boosting consumption, however this approach sacrifices saving and investment, reducing long run economic growth
what does the short run phillips curve show + explain them
- the short run phillips curve aids the debate of whether inflation is caused by demand pull or cost push factors
demand pull explanation
- excess demand causes unemployment to decrease, increasing price level
cost push explanation
- falling unemployment means trade union power increases, enabling unions to use their growing power over supply of labour to push for higher wages
describe the link between the long run and short run phillips curve
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