Economic Performance

Question 1

What is economic growth and the difference between short run and long run

Answer 1

• economic growth is an increase in real GDP in an economy in a year
• caused by increase in AD or an increase in LRAS

Short run economic growth - is when the economy is using spare capacity to increase the output of goods/services in economy
-usually caused by an increase in AD and is referred as demand side growth
- short run growth can also be driven by by changes in the factors that influence SRAS leading to supply side growth

Long run economic growth- when there are sustained improvements in the quantity or quality of FOP
- so there’s an increase in the productive potential of the economy.
- is the trend rate of growth of real national output in an economy overtime

This growth driven by factors such as technological advancement, investment in human capital, population growth and r and d

Question 2

Causes of short run economic growth

Answer 2

• changes to any of the component of AD will cause short run economic growth to occur (increase in consumption, investment, gov spending or net exports who’ll cause a SHIFT in AD.
  Demand side growth can be illustrated in an AD/AS diagram through a rightward shift in AD
  Can also be illustrated using the PPC model.

Short run supply side growth is caused by anything that shift the SRAS curve in an economy
Such as fall in the COP, a decrease in taxes, or an increase in the level of subsidies
Effect: creates condition of excess supply in the economy, average price level fall, national output increases

Question 3

Causes of long run economic growth

Answer 3

Is caused by any improvement to the determinants of LRAS
- illustrated on a AD/AS diagram by rightward shift in the LRAS

• LRAS can shift when there’s a change in the quantity or quality of FOP such as:

Land- additional land for production becomes available = finding new resource= productive potential of economy will improve= LRAS increase

• also able to build infrastructure such as building new roads, new airports, new railway lines= reduce the long run cost for all business in economy as transporting goods/s becomes quicker, more efficient = shifting LRAS to right= improving productive efficiency of economy

Technological advances- more investments on r and d to improving technology such as machinery upgraded = economy produce good In a larger volume or improve quality of G/s produced= boost LRAS

Entrepreneurship- improved incentive to set up new business or invest in development of new g/s= boost in LRAS= more competitive market= encourage firms to be more efficient in their goods

Demographic changes and migration- if there’s a net inward migration and majority of population is working age = size of labour force you going to be significant= economy can increase output

Government regulation= could limits how productive and efficient a firm can be if it’s excessive. Referred to as red tape

Changes in education and skills= improve the quality of human capital= so it more productive and more able to produce a wider variety of G/s

competition policy- a more competitive market encourages firms to be more efficient and more productive, so they are not competed out of business
Government can use effective policy to stimulate this in the economy

(Can also shift to the right due to improvement in productive efficiency of the economy)

Question 4

The benefits and cost of economic growth

Answer 4

Consumers:
Benefit—
Average consumer income increases as more people in employment and wage increase as productivity increases
Higher GDP can lead to improved standards of living for the population like better healthcare and education= overall enhanced quality of life
- reduction of absolute poverty

Increase length of people lives so increase life expectancy = reduce in disease

Cost:
Don’t benefit everyone equally= widens income inequality = low fix income feel worse off if there’s high inflation= create larger divides
Conflicting objectives- higher demand pull inflation, due to high level of consumer spending
Benefits of more consumption might not last after first few units due to law of diminishing returns= states that utility consumer derive from consuming a good = diminished as more of a good is consumed

Firms:
Benefits
Increase in profit /: there’s more spending= increase investment also driven by high level of confidence
-high level of investment= increase innovation develop new tech to improve productivity and lower average cost in long run
More competitive in export market== make them more efficient

Cost
As population increase= food supply may not keep up
May face menu cost of higher inflation( keep changing their price to meet inflation )
- utilizing more finite resource such as coal, oil and gas= resources are depleted= cause problems of failure overtime = less sustainable long run economic growth might be

Government
Benefits
- gov budget may improve= since fewer people require welfare payment = more people will be paying tax
- public services improves= as gov have more tax revenue =as gov can afford to improve services. Allocate funds for I build better roads, public transport = increase quality of education and life expectancy
- as income increases some might show concern about the environment
-lead to more civilized communities ( less crime rates)

Cost
- lead to damage to the environment in the long run due to increase in negative externalities from consumption and production of some g/s= affects current living standards
Pollution and berating of plastic waste, degradation of natural resources due to increase demand for it , deforestation = long term consequence on ecosystems and public health
- if scarce resource reduce, demand increase due to rising income= create inflationary pressure in economy= reduce income if inflation worsen= may require gov intervention

Economy
- improved international competitiveness, improved public services,lower unemployment BUT= inequality = worsening balance of payment on current account deficit through running demand for imports

Environment
Positive- larger budget for r and d into sustainable technology

Question 5

Evaluation on economic growth

Answer 5

• use appropriate policies such as tax and subsidies to minimize environmental damage— like environmental tax, carbon tax
• use appropriate policies such as progressive tax to ensure inequality don’t become too inequitable
• can impact the economy= employment rate rise, standard of living might improve= investment in education, healthcare
• may negatively impact environment
• conflicting objectives
• economic growth may not be sustainable= economic cycle vary over time =
  Sustainable economic growth is the rate of growth that can be maintained that does not compromise the quality of life for future generations

Question 6

The economic cycle

Answer 6

Refers to stages of economic growth is in
Economy goes through a period of boom, slowdown, recession and recovery

The real GDP will fluctuate above and below the long-term trend rate of growth

The long-term trend rate of growth refers to the average or long-term rate at which an economy expands over time
It represents the underlying, sustainable rate of growth that an economy can achieve over the long run, after accounting for fluctuations caused by the economic cycle

Diagram analysis
A positive output gap is identified as growth of real GDP that is above the trend
Occurs when actual level of output is greater than potential level of output

A negative output gap is identified as growth of GDP that is below the trend
There is often a natural flow through the different stages, from boom to slowdown to recession to recovery
This flow of real GDP can be moderated by government intervention
E.g. Increasing taxes in a boom period or increasing spending in a recession will help the economy stay closer to the long term trend

Question 7

Characteristics of boom and recession

Answer 7

Boom
- full employment
- demand pull inflation
- current account deficit
- consumer/ firms have lot of confidence
- budget surplus = gov rev exceed spending
- high rates of economic growth

Recession
- low inflation rate
Negative economic growth
- rising high employment
- less confidence- less spending/investment
- lots of spare capital
- gov budget deficit

Question 8

The causes of economic instability

Answer 8

Unsustainable growth occurs around the boom section of the business cycle= are essentially deviations from trend rate of growth

Excessive growth in credit and levels of debt
High levels of borrowing and spending occur during an economic boom- due to confidence
- whilst this additional consumption = initial boost AD= stimulate economic growth= at some point additional borrowing will need to be repaid
The period leading up to the 2008 financial crisis saw a surge in mortgage lending and high levels of household debt
Which in turn led to economic downturn (recession) when the level of debt became unsustainable = unable to afford their credit repayments

Asset price bubbles

Rapid increases in asset prices, such as real estate or stocks, occur during the expansion phase when consumer confidence is high=they predict asset to rise significantly
This is often driven by access to low interest loans
Then when price suddenly fall to its ordinary level= cause panic and investors try to sell their assets= loss of consumer confidence = lead to economic decline
The housing bubble burst in 2008, signalling an onset of a recession

Animal spirit / herding

Keynes coined the term animal spirits to describe how investment prices rise/fall based on human emotion= if firm expect a high rate of return= invest more= have high level of confident in an economy

Herd behaviour occurs when individuals mimic the actions of others, assuming that a collective decision is more accurate or rational than an individual one, in financial markets= could cause instability in market
- some investors think other economic agents are better informed about the market

For example, most individuals are not experts on the housing market. If house prices are rising and many ‘experts’ advocate buying, that might be the best information they have. Therefore, individuals can be swayed by movements of the market
In the years 2003-2007, there was a global rise in house prices

Economic shocks

Demand and supply side shocks in the economy
can lead to sudden and significant changes in economic conditions
The Covid Crisis and the fallout from Brexit impacted the supply side, leading to stagflation in the UK with high inflation and economic recession

A demand shock occurs when there is an unexpected change in demand. Such as recession= cause country export to decrease due to less demand from abroad

A supply shock, on the other hand, is when there is an unexpected change in supply= like war= inhibit economic ability to output goods/services
Discovery of new resources= potential for supply to go up

Question 9

The main UK measures of unemployment,

Answer 9

claimant count and the Labour Force Survey

Question 10

What is unemployment and the significance of it

Answer 10

Unemployment is the number of people looking for jobs but cannot find a job at a pint in time

Significance
-consumers—
If unemployed= less disposable income.= standard of living may fall
Also psychological consequences of losing job, could affect mental health of workers

Firms—
High rate of unemployment = have a larger supply of labour to employ from= cause wages to fall= help reduce firms cost
-however high unemployment = since consumers have less disposable income.0 consumer spending fall so firm may lose profit

Workers
- unemployed= waste of human capital resource=could lose existing skills if they are not fully utilized= operate within the PPF boundary
- cause inactivity = those not actively looking for jobs. = they may be discouraged = size of labour force may decrease
Government
- high unemployment = government may spend money on JSA= opportunity cost with investing elsewhere

• gov could also receive less revenue from income tax since unemployed have less disposable income

Society
-could cause negative externalities like crime and vandalism if unemployment rate increases

Question 11

The concept of voluntary and involuntary unemployment

Answer 11

• voluntary unemployment- occurs when workers choose to remain unemployed and refuse job offers at current market wage rate
  This could be encourage in welfare payment are generous relative to real wage
  High income tax= discourage people for participating in labour market

involuntary unemployment- occurs when workers are willing to work at current wage rate but no job available
- usually cyclical since caused by fall in AD
- occurs when there’s excess supply of labour= or economy not operating at FE

Question 12

What is seasonal unemployment

Answer 12

• occurs when long term shift in structure of the economy impact upon the job market
  As a consequence a large pool of highly skilled workers are unable to find work as there’s limited demand for their labour

Such as labour is replaced by capital like car manufacturing ( technological change)= certain jobs no longer need to be performed by workers

Structural employment tends to increase in line with the pace of globalization = since production in manufacturing sectors moves abroad to countries with low labour cost= workers trained for these jobs will be unemployed as industry declined in size or removed from economy

Structural unemployment worsened by geographical and occupational immobility of labour
workers don’t have transferable skills to move to another industry = those facing structural unemployment likely to remain unemployed in a long run

-therefore workers need to gain new skills to find employment= takes time and costly

Question 13

Frictional unemployment

Answer 13

Occur as workers move between jobs. Typically short term
Often when don’t have perfect immediate info about labour market
This is why it’s rare to get 100% employment

Short term as time taken for I find vacancy, able to survive on benefits for short time

Question 14

Seasonal unemployment

Answer 14

• occurs when workers are unemployed at different times of the year
  Tend to happen in seasonal industries such as tourism and leisure when there’s more demand
• cause by factors like weather

Question 15

Cyclical unemployment

Answer 15

Also known as demand deficient unemployment
Linked to the economic cycle, occurs when there’s a negative output gap
Indicated demand is low, occurs during periods of recession

If economy in recession and operating at point X, firm don’t need to employ as many workers as demand has fallen so don’t need to produce as many goods
As economy recovers= move to positive output gap= cyclical unemployment will reduce
Can be caused by increase in productivity

Question 16

Demand side and supply side factors affecting unemployment

Answer 16

Demand side factors such as cyclical unemployment is caused by insufficient AD in the economy-
So demand deficiency
Firms either force to close or make workers redundant = profit falling due to less consumers spending= don’t need to reduce cost

Supply side factors- such as frictional and structural unemployment caused by mismatches between demand and supply
It affects the position of the long run aggregate supply curve

Question 17

Government response to each type of unemployment

Answer 17

• structural unemployment :
  Retrain workers for needed employment areas
  Focus on enhancing unemployed individuals characteristics for improved employability

Seasonal unemployment- gov could subsidize innovation in industries where operational season could be extended such as helping farmers to develop polytunnels on their farms to extend growing season

Frictional unemployment- better information vacancies=implementing retraining schemes for workers= aim for a better match of workers skills with employer needs

Cyclical unemployment- take measure to stimulate AD- monetary and fiscal policy to counteract unemployment
Lower taxes for labour=. Incentive to workers

Should gov be concerned with seasonal unemployment;
Yes- unemployment = waste to resource= not working in their productive potential
No- likely to affect small number of people, usually students working in seasonal industries

Question 18

What is real wage theory of unemployment

Answer 18

• is unemployment caused by real wage being stuck above equilibrium Market = clearing real wage
• this is due to supply of labour exceed demand
  -classical economics argue by letting wage fail to equilibrium level= no unemployment

Caused by the existence of minimum wage laws
High wage creates an excess supply of labour
This excess supply represent real wage unemployment

Question 19

What’s the natural rate of unemployment

Answer 19

Is the unemployment when labour market is at equilibrium
- frictional, structural unemployment make up equilibrium unemployment
- there’s always be people moving between jobs or a level or structural unemployment

So full employment does not mean that everyone in the working population is willing to work

In the long run, unemployment rate reverts to the natural rate of unemployment. However it fluctuates around due to economic variable

Question 20

How natural rate of unemployment can be reduced

Answer 20

Policies to reduce occupational immobility (. Better retraining scheme)

Reduction in welfare benefits = reduce frictional unemployment

Reduction in direct tax= to make working more attractive

Question 21

The consequences of unemployment for individuals and for the performance of the economy

Answer 21

Waste of human capital= could lose their existing skills if it’s not fully utilized = operate within PPF boundary

Gov could receive less income tax since unemployed have less disposable income

Gov may have to spend more on JSA= opportunity cost as money could be invested elsewhere

Higher unemployment = larger supply of labour to employ from= wage can fall= help reduce firm cost
However since consumers have less disposable income= consumer spending fall so firm lose profit

Reduces international competitiveness by reducing the incentive for firms to invest

Question 22

How can government reduce unemployment

Answer 22

• better info about job vacancies

Lower tax on labour

Better training/ re skilling

Less generous welfare benefits= help encourage people to accept jobs

Relevant point - cyclical unemployment can be reduce by policies that increase AD

Question 23

Should Gov be concerned with seasonal unemployment

Answer 23

Yes- unemployment = waste to resource= workers could contribute to GDP

No- likely to affect small numbers of people,
Usually students working in seasonal industries not looking for permanent work

Question 24

Concept of inflation, deflation and disinflation

Answer 24

Inflation is the sustained rise in general price over time
Means cost of living increase , purchasing power of money decrease
If wages remain constant , then price rises with their disposable income, they will buy less g/s= erodes the value of money

Policy delegated an inflation target of 2%
Monitoring this low rate gives firm confidence to invest in capital expenditure = increase long run AS= provides jobs in the future

Deflation
A decrease in general price level. There’s a negative inflation rate
Deflationary gov policies is when government aims to reduce AD, do not necessarily result in deflation

Disinflation
Is the falling rate of inflation but it is positive. Therefor average price level still rising but at slower rate

Hyperinflation- when inflation rate rises rapidly and accelerated out of control
Money becomes worthless
People resort to using other countries to pay for g and service

Question 25

Causes and problems of deflation

Answer 25

Tend to occur during periods of low growth

Deflation generally indicated demand very low or suppressed
As price decreases, consumer tend tend to delay purchase decision, think price will fall in future
Result consumption slowing

Means firm lose confidence to invest , harming AD further

Question 26

Causes of inflation

Answer 26

Demand pull inflation-is the rising price level caused by an increase in AD, shown by shift of the AD curve to the right.
When AD is growing unsustainably, there’s pressure on resource
Producers increase price and earn more profits

Main trigger for demand pull inflation are:
- high growth in UK export so AD increase
Depreciation in exchange rate= imports become expensive= export become more cheaper = AD rises
- fiscal stimulus in the form of lower tax or more government spending= consumers have more disposable income= consumer spending increases
Lower interest rate= saving less attractive= so consumer spending increases

Cost push influence on the price level- rising price level caused by increasing cost of production of production shown by shift in SRAS curve. Firms facing rising cost.

Occurs when:
- labour becomes more expensive= could be through trade unions

Expectation of inflation - if consumer expect price to rise= ask for higher wages to make up for this= trigger more inflation
Reason why government has inflation target so it encourages workers to moderate their wage claims

• depreciation in exchange rate = imports more expensive= pushes up price of raw materials

Changes in world commodity prices such as raw material can become more expensive. If oil price rises= increase COP

Monopolies- using their dominant market position to exploit consumer with higher prices

Question 27

Effects on inflations

Answer 27

Consumer
If income does not go up the same rate as inflation= real income will decrease over time
Low and fix incomes= loss of purchasing power of money for households in economy= necessities becoming expensive. Affects high income the least
- if consumers have loans, value of repayment be lower, so real value of debt decrease (. Benefit)

Firms
Low inflation=- low interest = borrowing = investing more attractive than saving profit ( benefits)
High inflation = interest rate likely higher= cost of investing higher so firms are less likely to invest •less confident since they not aware of what the cost will be
Might demand higher wages= increase in cost of production

The government
Have to increase value of state pension and welfare repayments as cost of living is increasing
Also low inflation rate improve gov finance as price raises = give can collect more revenue from taxes such as fuel duty(. Benefits)

Workers
Real income falls= have less disposable income
If firms have higher cost, could be redundancies when firms try cut their cost

Economy
- reduce international competitiveness = price increasing at faster rate compared to other countries= mean countries become less competitive over time

Question 28

How does changes in world commodity price affect domestic inflation

Answer 28

Globalization has increased the interconnectedness of economies, and when commodity prices increase from a strong dollar, this typically results in domestic deflation.

While commodity prices are not 100% indicative of inflation, they can be a good starting point when attempting to hedge against inflation.

Question 29

The consequence of deflation for both individuals and the performance of the economy

Answer 29

The UK experience shoe period of deflation in April 2015, when price fell by 0.1%
Before UK experience deflation in 1960

Deflation discourage spending= makes g/s cheaper in the future, can result in economic decline and increase the rate of unemployment
Wages likely to fall since firms makes less profit= consumer have less disposable income

Make real value of debt higher = consumers with high level of debt find it harder to pay it off= since larger proportion of their income be used to make repayments
However can be good if results of increase in LRAS, leads to a higher real GDP

Question 30

How to changes in other countries affect UK inflation

Answer 30

• rising inflation in china as income in china drives their own inflation rate fiber mean import from china more expensive = drives up UK cost= push inflation

Question 31

Fisher equation of exchsnge

Answer 31

Equation
Money supply x velocity = price level x quantity of output

Therefore the value of expenditure on goods= value of outpuewuation assume velocity is constant , Q is independent of supply of money. Only supply side factors affect Q

This equation argues increasing money supply causes inflation

When money supply increase consumers have more to spend= AD to shift to right. Firms increased supply in the short term run= positive output gap occurred which is inflationary

As a result more workers are employed= so wages increases = increase in cost for firms= puts up prices

There can be a contraction in demand as real value of money falls

Workers demand higher wages to make up for the increase in inflation= shift left in the SEAS curve
Output in economy returns to equilibrium, but price levels higher

Question 32

Evaluate inflation

Answer 32

Cause - inflation- demand pull more favorable than cost pull= with DP= get higher growth, lower unemployment, but with cost push

Also easier to solve contractionary demand side policy, whereas cost push when it gets out of control= nothing you can do

Stability of the rate= if it’s more volatile= risky inflationary noise harming consumption and investment in economy

Question 33

Possible conflicts between macro policy objectives

Answer 33

Economic growth vs inflation

A growing economy is likely to experience inflationary pressures on the average price level. This is especially true when there is a positive output gap and AD increases faster than AS.

A negative output gap occurs when the actual level of output is less than the potential level of output. This puts downward pressure on inflation. It usually means there is the unemployment of resources in an economy, so labour and capital are not used to their full productive potential. This means there is a lot of spare capacity in the economy.

A positive output gap occurs when the actual level of output is greater than the potential level of output. It could be due to resources being used beyond the normal capacity, such as if labour works overtime. If productivity is growing, the output gap becomes positive. It puts upwards pressure on inflation. Countries, such as China and India, which have high rates of inflation due to fast and increasing demand, are associated with positive output gaps.

Economic growth vs the current account
During periods of economic growth, consumers have high levels of spending. In the UK, consumers have a high marginal propensity to import, so there is likely to be more spending on imports. This leads to a worsening of the current account deficit.
However, export-led growth, such as that of China and Germany, means a country can run a current account surplus and have high levels of economic growth.

Economic growth vs gov budget deficit
Reducing a budget deficit requires less expenditure and more tax revenue. This would lead to a fall in AD, however, and as a result there will be less economic growth.

Economic growth vs environment
High rates of economic growth are likely to result in high levels of negative externalities, such as pollution and the usage of non-renewable resources. This is because of more manufacturing, which is associated with higher levels of carbon dioxide emissions.

Unemployment vs inflation
In the short run, there is a trade-off between the level of unemployment and the inflation rate. This is illustrated with a Phillips curve.
As economic growth increases, unemployment falls due to more jobs being created.
However, this causes wages to increase, which can lead to more consumer spending and an increase in the average price level.

Question 34

what is the Phillip curve

Answer 34

The short-run Phillips curve represents the trade-off between unemployment and inflation. In the short run, the Phillips curve is roughly L-shaped, which shows how as unemployment increases, inflation decreases. The above Phillips curve is for the short run.

The long run Phillips curve is L-shaped. It is also known as the vertical long-run Phillips curve (shown below). It is at the natural rate of unemployment, and there is no trade-off between unemployment and inflation. The two variables are unrelated.

Implication
If the government tries to lower unemployment in the short run, there could be inflationary pressure on the price level. In the short run, the economy suffers from demand-deficient unemployment. This might encourage the use of demand-side policies to tackle unemployment.

In the long run, changes in the unemployment rate do not affect the inflation rate.
Therefore, policies can be more flexible. Since there is no demand-deficient unemployment in the long run, supply-side policies are more likely to be used.