Chap 25 Flashcards
Main government aims for the economy
- Economic growth
- Low unemployment
- Price stability
- Balance of payments stability
- Redistribution of income
Define Economic growth
An increase in the output of an economy and in the long run, an increase in the economy’s productive potential
Define Actual economic growth
an increase in the output of an economy
Define Potential economic growth
an increase in an economy’s productive capacity
How can the productive potential of the economy be increased ?
Rise in the quantity and/or quality of factors of production.
Define Aggregate demand
The total demand for a country’s product at a given price level.
It consists of consumer expenditure, investment, government spending and net exports (exports – imports)
C + I + G + (X - M)
Define consumption (C)
Spending by households on goods and services
Define Investment (I)
Spending by the private and public sectors on capital goods
Define government spending (G)
Government spending on state-provided goods and services
Define net exports (X - M)
Value of exports minus imports
What causes an extension in aggregate demand?
A fall in the country’s price level
(a) households and firms would have more purchasing power
(b) it increases the international competitiveness of the country’s product
Causes of an increase in aggregate demand (shift to the right of the AD curve)
- Increase in population
- Cut in the rate of interest
- Lower exchange rate
- Greater confidence
Define Aggregate supply
The total amount of goods and services that domestic firms are willing to supply at a given price level
Reasons why governments aim for economic growth
- Raise people’s living standards
- Transform people’s lives and enable them to live longer because of better nutrition, housing and healthcare
- Help a government achieve its other economic aims
How does economic growth help a government achieve its other economic aims ?
Employment: As output increases
Low price level: If output increases to match higher demand
Trade position: Extra output is exported
Extra tax revenue: Poor may gain jobs and some may be helped
Determinant of a country’s possible economic growth rate
Level of output, in relation to its current maximum possible output and its growth in productive capacity
Growing rate + productive capacity = possible economic growth rate
Define Full employment
the lowest level of unemployment possible
Define Economically active
being a member of the labour force
(willing and able to work at the going wage rate)
Define economically inactive
They include children, the retired, those engaged in full-time education, home makers, the sick/disabled who are dependent on those in the labour force.
Unemployment rate formula
(Unemployment/Labour force)* 100
Define Unemployment rate
the percentage of the labour force who are willing and able to work but are without jobs
Reasons why governments aim for low unemployment
- Unemployment is a waste of resources
- Unemployed can suffer low income
- Government tax revenue may have to be spent supporting the unemployed
Why is it not possible to achieve 0% unemployment?
There will always be some workers changing jobs and being unemployed for short periods
Define Price stability
the price level in the economy not changing significantly over time
low and stable inflation
Reasons why governments aim for price stability
- Ensures greater economic certainty
Firms will not raise their prices because they expect their costs to be higher
Households will not bring forward purchases for fear that items will be more expensive in the future
Workers will not press for wage increases just to maintain their real disposable income
- Prevents the country’s products from losing international competitiveness.
Define Inflation rate
The percentage rise in the price level of goods and services over time
Why don’t they aim for unchanged prices?
- Measures of inflation tend to overstate rises in prices
- Slight rise in prices can provide some benefits
How do measures of inflation tend to overstate rises in prices?
People buy some products at reduced prices in sales and also make second-hand purchases
Price rises can also hide the improvements in products
How can a slight rise in prices provide some benefits?
- Can encourage producers to increase their output, as they may think that higher prices will lead to higher profits
- Can enable firms to cut their wage costs by not raising wages in line with inflation/ cut in employment
Why do governments try to avoid a fall in the price level?
(caused by a fall in aggregate demand)
This is because it could result in a decline in output and a rise in unemployment.
Define Balance of payments
The record of a country’s economic transactions with other countries.
Key part of a country’s balance of payments
Record of revenue received from selling exports and its expenditure on imports.
Reasons why governments aim for balance of payments stability
Imports > Exports: Country will be living beyond its means and will get into debt
Export > Import : The inhabitants of the country will not be enjoying as many products as possible.
Reasons for a deficit of export revenue
- Increase in the import of raw materials and capital goods
- Fluctuations in income at home and abroad.
Why would an increase in the import of raw materials and capital goods not be of concern ?
The products purchased may increase the economy’s ability to produce more goods and services to sell at home and abroad.
How does the government redistribute income?
The rich are taxed more than the poor.
Some of the money raised is spent directly on the poor by means of benefits such as housing benefit and unemployment benefit.
Other forms of government expenditure, such as that on education and health, particularly benefit the poor. Without the government providing these services free of cost or at subsidised prices, the poor may not find them accessible.
Reasons why governments may seek to redistribute income
- Hardships it causes
- Can also cause social unrest as the poor may feel a sense of social injustice.
- Inequality can grow- Rich tend to marry the rich and benefit from better education and have more opportunity to save.
Governments are unlikely to aim for a perfectly equal distribution of income because
Taxing the rich too heavily may act as a disincentive to enterprise
Providing too generous benefits may act as a disincentive to effort
Why would full employment conflict with stable prices ?
A low level of unemployment is likely to push up wages as firms compete for workers. The resulting higher costs of production are likely to result in inflation.
Why would full employment and economic growth conflict with balance of payments stability?
Rise in employment is likely to increase incomes and spending on imports may increase by more than export revenue.
To produce a higher output, firms may also import more imported raw materials and capital goods.
