Economic Instability

Question 1

Instability is Not Good for an economy

Answer 1

1. Its normal for an economy to go through regular ups and downs - this is the economic cycle.
2. However, if these ups and downs are particularly large or particularly frequent, this can cause problems for an economy
3. Governments can try and control these ups and downs to a certain extent… but some things will be beyond their control.

Question 2

Economies can suffer from Demand-side Shocks or Supply-side Shocks

Answer 2

1. An economy might start to shrink or grow because its affected by a demand-side shock or by a supply-side shock.
   examples of Demand-side shocks:
   - Consumer confidence is boosted, e.g. due to house prices rising => increase consumer spending.
   - Countries major trading partners go into a recession, this may significantly reduce demand for the country’s exports.
   examples of supply-side shocks:
   - Poor harvest reduces the supply of food, increases its price, and reduces the economy’s capacity.
   - Discovery of a major new source of raw material will greatly reduce its price and increase its suppy - increasing the capacity of the economy.

Question 3

Instability can be caused by ‘Animal Spirits’

Answer 3

1. According to classical economic theory, economic agents always act rationally.
2. In fact people often seem to act very irrationally. Keynes uses the term ‘animal spirits’ to describe how human behaviour is often guided by instincts and emotions, rather than economic realities.
3. Common danger signs for the economy:
   - Excessive growth in credit and levels of debt
   a) when credit is cheap and consumers are feeling confident, they often spend more and accumulate debt.
   b) this => increase AD and => higher inflation. This inflation => higher interest rates, which could mean firms delay investment projects and come more cautious, storing up problems for an economy.
   c) High levels of debt also mean that if consumers lose confidence for any reason, they’re likely to greatly slow down their spending for fear of not being able to pay off their loans. It also means they’ll have less money to spend in the future, as they’ll be spending money repaying debts (including interest).

• Destabilising speculation and asset price bubbles
  a) speculation = when people buy assets and hope to sell them for a profit later
  b) Speculators often assume that an increase in the price of an asset means that its price will continue to increase in the future - this prompts further buying of the good and further price increases, leading to further buying and further prices rises etc.
• the ‘herding effect’ has been used to explain why this behaviour may occur.*
  c) This behaviour can => asset price bubbles - where prices increase way beyond the asset’s ‘true value’
  d) eventually the bubble bursts and asset prices start to fall. When this happens, people’s optimism and confidence disappear. If ppl start to fear they’ll lose money, they might start to sell off the assets => further price decreases, and further selling etc.
  e) Property and shares are often affected by asset-price bubbles, and the effects of a sudden fall in UK house prices, for example, can be dramatic. As people feel less wealthy and less confident, they start to save instead of spend, and this can => downward spiral in the economy.

Question 4

Sustainable Growt is Difficult to Achieve

Answer 4

1. Sustainable economic growth = making sure the economy keeps on growing without causing problems for the future generations. Sustainable growth relies on a country’s ability to:
   - Expand output every year
   - Find a continuous supply of raw materials, land, labour and so on, to continue production.
   - Find growing markets for the increased output, so it’s always being brought.
   - Reduce negative externalities, e.g. pollution, to an acceptable level so they don’t hamper production.
   - Do all of the above things at the same time as many other countries who are pursuing the same objectives.
2. Its very difficult for a country to do all of these things at the same time, so sustainable growth is hard to achieve.
3. To be able to achieve sustainable growth, countries will need to develop renewable resources. Non-renewable resources will run out and, for growth to be sustainable, a continuous supply of raw materials is necessary.
4. Countries will also need to innovate to create new technologies that reduce negative externalities, such as land or rivers, without stopping output from expanding.
5. A country that achieves sustainable growth will gain long-term benefits to society - it can more easily plan ahead, since it can be more confident about its long-term economic prospects.

Question 5

You need to know about the UK’s Recent Macroeconomic Performance

Answer 5

1. Need to keep an eye on the news and look for any important developments about the UK’s economy -e.g. there might be a rise in interest rates or a large fall in unemployment. Here are a few general points:
   a) From 2000 to 2008 the UK enjoyed continuous GDP growth of, on average, just under 3% each year. However in 2008 the UK went into a recession that lasted several months and was followed by a long, slow recovery.
   b) During the recovery the UK economy went through short bursts of growth followed by slow-downs - almost went back into recession in 2012. From 2013 onwards, the UK has had much more consistent GDP growth and, by 2014 GDP returned to the level it was just before the recession - recovery complete.
   c) Between 2000 and early 2015 the rate of inflation in the UK, as measured by the CPI has been quite steady - inflation generally between 0.5 and 3%.
   d) Some exceptions - on couple of occasins, inflation rose to about 5% - well above the government’s target of 2%. This happened just at the start of the recession in 2008 and again in 2011. Inflation then fell again and remained between 0 and 3% for some time.
   e) Unemployment in the UK remained quite low between 2000 and 2008 - between 1.4 and 1.7 million.
   f) Between 2008 and 2011 unemployment rapidly rose, reaching about 2.7 million. Since then unemployment has fallen, but, by January 2015, it was still higher than it was at the start of 2008.
   g) The UK has had a current account deficit in its b of p for the whole period between 1984 and 2014. The deficit was the largest during this period during the end of 2014.
   h) UK economy is currently dominated by its service sector, which accounts for approximately 77% of GDP. Manufacturing now accounts fo just around 10% of GDP.