Chapter 4: Macroeconomy Flashcards
define inflation
a sustained increase in average price level
limitations of price index (3)
- difficult selecting a base year - should be recent and not have economic crises
- difficult to determine which goods should be included - people spend on different goods
- different households have different importance of goods
- sample size may be too small or inaccurate
- CPI cannot determine the cause of a price increase
advantages of a low inflation (3)
- economic growth & employment (higher spending, investment rises)
- workers are less likely to demand higher wages
- exports are cheaper, domestic goods will be cheaper than imports
- trade balancee improves - more export revenue, less import spending
evaluate the extent of inflation (3)
- the rate of inflation - high inflation can reduce confidence in the economy → discourage spending & investment
- the rate of inflation compared to other countries - a country’s exports will improve if thee inflation is lower than other countries
- whether inflation is stable - if inflation is accelerating, consumers will expect prices to rise further → consumers will increase spending and worsen inflation - workers will demand higher wages
- cause of inflation - demand pull is less harmful than cost push because cost push means there is falling output
evaluate the extent of deflation (2)
- deflation is caused by a rise in aggregate supply - less damaging - may occur because of technology improvement → reduces production cost → more export revenue → more employment
- deflation caused by falling aggregate demand which causese falling growth - more damaging - falling employment → firms reduce investment
effects of a current account deficit
negative (3)
positive (2)
- increased foreign borrowing
- credit rating will fall - lenders will charge high interest rate & less hot money
- fall in economic growth - domestic firms will reduce output
- fall in exchange rate
- fall in foreign reserves
positive
- rise in imports may increase living standard
- firms can produce more by importing materials
evaluate the extent of current account deficit problem (3)
- it is short lasting
- many capital goods are imported to increase production
- growth rate is higher than CAD rate
what is marshall lerner condition
a depreciation will improve the current account balance if the sum of price elasticities of demand for exports and imports is more than one
what is j curve effect
if an exchange rate is lowered, the current account balance will worsen before improving
define trade protectionism
a policy that interferes with the market to give an advantage to domestic firms
types of protectionist policies (4)
- tariff - raises price of good and causes quantity demanded to fall
- quota - limited imports will raise the price of the domestic good
- devaluation - government devalue currency to increase exports
- administrative barriers - imported goods must meet some regulations
- subsidy - lowers price of domestic good, raises exports
- currency control - government set limits on foreign currency to reduce imports
reasons for trade protectionism (3)
- protect infant industries - too small to gain economy of scale (higher prod. cost), foreign firms may reduce prices to stop new firms
- protect employment - reduction of imported goods will encourage consumers to buy domestic goods
- prevent dumping - foreign firms can raise prices if domestic firms are driven out. policies will raise the price of the imported good
- reduce balance of payment deficit - higher import prices will reduce import spending
reasons against trade protectionism (3)
- rising inflation - higher import price, less competition → less efficient, more expensive capital goods
- less government revenue - more subsidy and less tax
- lower living standard - higher import price, less competition → less innovation, less technology transfer
economic intergration in order
free trade area → customs union → economic union
characteristics of free trade area
countries remove trade barriers on all goods
