Economic Environment

Question 1

GDP 6

Answer 1

calculated by adding together the
total value of all goods and services produced domestically during a calendar year.

• When the level of GDP falls compared with the previous quarter, the economy is said to
  be contracting.
• After two successive quarters of declining GDP, it is said to be in a ‘technical recession’
  (there is no universally agreed definition of a recession).
• When GDP rises compared with the previous quarter, the economy is expanding.

adjusted for inf;ation

production, income expenditure

Question 2

Public sector net cash requirement

Answer 2

the extent to which the public sector needs to borrow from other sectors of the economy and from overseas to finance the difference between expenditure
and receipts

Question 3

How does recession and expansion affect PSNR

Answer 3

tax revenues will be weak and spending on unemployment
will rise so that the PSNCR is likely to grow.

tax revenues will rise and spending on unemployment will
fall as more people find jobs, reducing the PSNCR.

Question 4

Producer prices
indices (PPI)

Answer 4

‘factory gate prices’ and studied as an early indicator
of inflationary trend

Question 5

Purchasing
managers’ index

Answer 5

health of the
manufacturing sector.

The index is a diffusion index, with scores above 50 representing
expansion and those below 50 suggesting contraction. The

Question 6

leading, coincident, lagging

Answer 6

stock market

GDP, industrial production, retail sales

unemployment

Question 7

balance of payments 3

Answer 7

record of the country’s trade transactions with
the rest of the world, measured in terms of receipts and payments.

• A receipt represents sterling flowing into the country, or
• A payment represents sterling flowing out of the country,

Question 8

current account?

Answer 8

imports and exports of goods and services;

Question 9

capital and financial account?

Answer 9

CA foreign investments in the UK and UK
investment abroad, as well as loans.

FA change of ownership of financial assets and
liabilities between a country’s residents and non-residents.

Question 10

What are the 4 parts of current account? and explain

Answer 10

Trade in goods
Trade in services

investment income
* the earnings on investments held by Britons overseas (which credit the balance of
payments); and
* the earnings on investments held by foreigners in Britain (which debit the balance of
payments).

transfer payments
Items such as overseas aid and contributions to international organisations.

Question 11

How is current account deficit met

Answer 11

must be financed by overseas lenders

Question 12

Explain capital account deficit and relationship with current account (3)

Answer 12

• The UK has a capital account surplus if overseas investors invest more money in the UK than UK investors invest overseas.

Any deficit on the current account balance must be made up by the capital account in the overall balance of payments through net investment into the country or loans from abroad.

If there is a net deficit on the combined current and capital accounts, the official reserves of foreign currencies owned by the Bank of England

Question 13

What are BOE reserves and what role do they play in balance of payments

Answer 13

If there is a net deficit on the combined current and capital accounts, the official reserves of
foreign currencies owned by the Bank of England will have to be used to finance it.

• foreign currencies;
• gold;
• International Monetary Fund (IMF) special drawing rights (SDRs); and
• the UK’s reserves tranche position at the IMF.

Question 14

what is real exchange rate and what do rise and falls do (4)

Answer 14

have been adjusted to incorporate the
differences in their rates of inflation.

he real exchange rate measures the
price of domestically produced goods relative to the price of foreign goods,#

rises: domestic goods become more expensive relative to foreign goods, adversely
affecting domestic production; or

falls: domestic goods become relatively cheaper and demand for them increases.

Question 15

explain difference between fixed and floating

Answer 15

set by government

supply and demand

Question 16

How does balance of payments affect exchange rates

Answer 16

If there is a surplus on the current account, i.e. a country exports more goods and services than it imports – strengthens

a current account deficit implies the need to sell the local currency to acquire
foreign goods. This would lead to a change in the demand for that currency, which would
cause a change in the exchange rate, with the currency weakening in value.

Question 17

2 downsides of strong currency

Answer 17

• A higher currency value will make exports more expensive, weakening the country’s
  competitive position and potentially reducing exporters’ profits.
• Manufacturers find that their products will become too expensive to compete with those of
  other countries in both export and home markets, so domestic manufacturers will suffer

Question 18

4 effects if rising exchange rates

Answer 18

exports more expensive, reduces demand

import cheaper, demand increases

Aggregate demand falls, lower growth

inflation falls - cheaper prices imported goods, lower agg demand, less demand pull inflation

Question 19

5 effects of falling exchange rates

Answer 19

more competitive exports, increases demand

more expensive imports reduces demand

higher agg demand and so growth

rising inflation

improve current account on BOP

Question 20

How can IR affect ER

Answer 20

US bonds higher yield than UK.

Buy dollars and sell pounds

Question 21

biggest impact on ER now

Answer 21

capital not trade flows

Question 22

ER effect on domestic shares

Answer 22

UK firms that benefit from a rise in the value of the pound are those that rely on a
substantial level of imports; for example, raw materials or components.

• Those that benefit from a fall in the pound are those that export to other countries.

Question 23

How does gov affect demand through fiscal policy

Answer 23

• In a recession or times of low economic activity, the government may increase its
  spending and/or cut taxation to stimulate demand.
• In a boom, the government may reduce spending and/or increase taxation to
  dampen demand.

Question 24

Give 4 impacts of budget deficits

Answer 24

Rising IR which reduces economic growth

Interest rate on gov debt becomes high element of public spending

Private sector investment reduced to meet public sector demand

Higher taxes or public spending cuts to pay back

Question 25

what is current account definition (exam Q) 4

Answer 25

Import minus
exports in
goods, services and
overseas income generating assets

Question 26

Capital account def exam q (3)

Answer 26

Movement of all money and assets in and out of country

Question 27

Narrow money M0

Answer 27

– notes and coins in circulation; plus
– banks’ operational deposits with the Bank of England.

an indicator of consumer spending and
retail sales:

– Growth in M0 indicates that consumer spending is buoyant.
– A contraction in M0 suggests that consumers are behaving more cautiously.

Question 28

M4 broad money

Answer 28

– notes and coins in circulation; plus
– all instant access and time deposit accounts of UK residents with UK banks and
building societies.

– An increase in the demand for loans will be reflected in a faster growth in M4.

– Rapid growth in money circulating in the economy is often interpreted as a build-up
of inflationary pressures.

Question 29

explain step by step how money supply causes inflation (3)

Answer 29

quantity of money increased without increase in goods and services

the value of each unit of money will fall.

an excess of consumer demand over the supply of goods, which will force up the general level of prices

Question 30

what is volicity

Answer 30

GDP:stock of money

The faster the velocity of circulation, the greater the
impact of a given stock of money on prices

Question 31

How do repos affect IR (2)

Answer 31

BOE lend - inject money - lower rates

BOE borrow - reduces money - higher rates

Question 32

causes of inflation 5

Answer 32

demand pull - prices rise

cost push - cost of materials

imported inflation - fall in £ compared to importing materials from

wage increases

lack of supply eg war

Question 33

what causes deflation

Answer 33

supply of goods rises faster than the supply of money, the
purchasing power of money increases and the general price level of goods falls.

Question 34

deflation cycle 5

Answer 34

Consumers reluctant to buy expensive items, as cheaper in the future.

Borrowers are committed to making loan
repayments more of their purchasing power, while asset purchased with the loan is declining in nominal price.

• manufacturers will reduce output as it is difficult for
  them to recover the cost of producing those goods. This will lead to a reduction in profits.
• reduced output and profits will lead to
  businesses cutting their workforce, creating unemployment.
• This will lead to further reductions in sales so that production has to be further reduced.

Question 35

CPI, CPIH and RPi

Answer 35

prices of consumer goods
and services bought by consumers within the UK - benefits inc SP

includes owner occupiers’
housing costs (OOH) along with council tax so diff weighting

RPI - DB and IL gilts

Question 36

electoral cycle?

Answer 36

generate boom before election then cool down once new gov in

Question 37

3 effects of globalisation

Answer 37

• Investors can take advantage by investing in foreign markets
• It puts at a disadvantage low-skilled, labour-intensive industries in the developed world that compete with developing countries.
• UK financial services companies have outsourced call-centre operations to India, administrative work and software development.

Question 38

5 impacts of politics

Answer 38

uncertainty

trade policy

tax/spending polices

war

terrorism