Economic Performance Flashcards
Key government objectives (6)
Price Stability (CPI of 2%)
Growth of real GDP
Raising employment
Raise average living standards
Equitable distribution of income and wealth
Stable balance of payments
Additional government objectives
Balancing the budget and reducing national debt, improved economic well-being, better regional balance, improves access to public services, improved competitiveness, environmental sustainability
Human Development Index (HDI)
Income, infrastructure, education, healthcare, utilities, employment, inflation, crime rate, environment etc. Equally weighted between an index number representing GNI per capita, life expectancy and number of years of schooling.
What is economic growth
An increase in real GDP in an economy in a year caused by an increase in AD or an increase in LRAS
Short-Run (Actual) Growth
Measured by the percentage change in real national output. It takes up spare capacity within the economy, brings idle resources into production, and is primarily caused by demand-side changes in the economy. As the AD curve shifts closed to the potential capacity level of output, short run growth is followed by higher rates of inflation, when there are no longer any idle resources for growth to continue it must be long-run growth
Long-Run (Potential) Growth
Increase in the capacity or productive potential of the economy. This usually happens due to a rise in the quality or quantity of FOP.
The trend rate of growth
Rate at which output can grow on a sustained basis, without putting upward or downward pressure on inflation. It reflects the average percentage increase in the productive capacity of the economy
How to increase productive capacity
Improvements in technology from investment, increases in size of labour force, improved productivity, infrastructure improvements, increase competition
Costs of economic growth
Uses finite resources such as oil which cannot be replaced. Leads to pollution and other forms of environmental degradation- can impact standard of living. Widen inequalities in distribution of wealth and income. Demand-pull inflation as demand increases faster than supply can also do cost-push inflation as demand for resources increases, pushing up prices. Deficit in balance of payments as people on higher income buy more imports
Benefits of Economic Growth
Increase the demand for labour, fall in unemployment. Higher wages mean higher disposable income so better standard of living only if prices don’t rise more than wages. Firms earn greater profits, more investment to increase economy’s productive potential. Output will increase which can improve balance of payments. Increase in gov tax revenue. Reduces need to borrow. Better fiscal position. International competitiveness
The impact of growth on individuals, the economy and the environment
Growth may consume more finite resources leading to a depletion and degradation. Increase international competitiveness of the economy which implies other less competitive economies will not enjoy fruits of rapid growth. Higher welfare, incomes, and better prospects for the future however poorer suffer from losses of jobs and increase inequality
Economic cycle
Actually output is the level of real output produced in the economy at a particular year. It rises and falls in different phases of the economic cycle
The stages of the economic cycle
Recovery occurs when real GDP begins to grow after the end of a recession or downturn. With continuing short-run growth in real output, recovery gives way to the boom/peak phase in the cycle when the level of real output becomes greater than the trend level of output. The boom ends at the turning point when entering a recession.
Effects/Causes of a boom
Inflation increases- excess AD pushes up prices
Business confidence is higher increasing private sector investment
Unemployment decreases but eventual labour shortages may lead to inflation
Consumption increased, Budget surplus, Increased tax revenue, High demand for imports
Effects/Causes of a Downturn
Unemployment stops falling
Inflation stops rising, Move towards budget deficit as tax revenue decreases, Collapse of confidence leads to investment projects cancelled or postponed, Consumers will reduce amounts borrowed
Effects/Causes of a Recession
Growth is negative, Unemployment increases or reaches highest levels, inflation decreases as price falls, consumption decrease due to falling incomes, Budget deficit at its highest, Less tax revenue, Low investment, Current account balance is likely to be narrow and may move into surplus
Effects/Causes of Recovery
Short-term growth will resume, AD is rising, Inflation is rising but remains lower, Unemployment will stop rising and start to fall, Investment increases, Budget deficit stops rising
Output gaps
Occurs when the level of actual real output in the economy is greater or lower than the trend output at a particular point. When actual output is above trend output there is a positive output gap and when it’s below there is negative
Negative output gaps
Occurs during a recession when the economy is under-performing, as there will be a lot of spare capacity which usually means a downwards pressure on inflation
Positive output gaps
Occurs during a boom, as resources are fully being utilised or even overused, usually means upwards pressures on inflation
Causes of changes in the phases of the economic cycle
Fluctuations in AD, demand or supply side shocks which impact AS and AD, role of speculative bubbles, changes in inventories, multiplier - accelerator interaction, animal spirits, excessive growth in credit
Speculative bubbles
Rapid economic growth leads to a rapid rise and speculative bubble in asset prices. When people realise that house price or share prices rise far above the assets real values, asset selling replaces buying. This destroys consumer and business confidence as prices fall rapidly and people stop spending so economy falls into recession
Changes in inventories
Stocks of unsold finished goods build up when firms over-estimate demand for finished goods (in downturns or recession demand will be lower). As the stocks accumulate, firms are forced to cut production by more than the original fall in demand rather than producing more. The resulting restocking turns a slowdown into a recession
Multiplier - Accelerator interaction
The multiplier process, through which an increase in investment leads to multiple increases in national income; and the accelerator, through which the increase in income induces a change in the level of investment. Investment affects income which in turn affects investment demand
Animal spirits
Collective expectations of businesses and consumers. If confidence is low, then even with low interest rates the economy may remain in a recession phase as the result of it being expected to be there
Excessive growth in credit
When credit is cheap and consumers are feeling confident, they often spend more and accumulate debt. This can increase AD and lead to higher interest rates which could mean firms delay investment projects. High levels of debt mean if consumers lose confidence, they will slow down their spending and will have less disposable income, pushing the economy into a recession
Inflation, Disinflation, Deflation
Inflation is the sustained rise in the average prices of goods and services over a period of time. Disinflation refers to the concept of a falling rate of inflation, prices are still rising but at a slower speed. Deflation is the sustained decrease in general price level of goods and service over time i.e. they are cheaper to buy than the previous year
Demand-pull inflation
A rise in prices is caused by an increase in AD. As firms reach full capacity, more pressure is out on existing FOPs (they are becoming scarcer) so as a result prices will rise leading to inflation. If the economy is producing below the productive potential the price level must rise to persuade firms to produce more output and meet extra demand to profit maximised
What can cause demand-pull inflation
Lower interest rates, lower income and corporation tax, increased consumer/business confidence, increase gov spending, weak exchange rate, high demand for exports, money supply growing faster than output
Cost-push inflation
A rise in price level caused by an increase in the costs of production, with rising costs producers tend to pass on the higher costs to consumers to maintain profit
Causes of cost-push inflation
Increase in price of raw materials, Increase in wages above any levels of productivity, Rise in indirect taxes, Weaker exchange rate increased price of imported goods
Quantity Theory of Money equation
M (money supply) x V (velocity of circulation) = P (average price level) x Q (quantity of goods/services sold)
Monetarist v Keynesian approach to QTM (quantity theory of money)
Monetarists argue that in short run V is constant or at least stable, this means when M increases it is spent on goods and services. If Q is unable to increase or unlikely to change, P is pulled up by excess demand so any increase in P will be directly caused by increases in M. In contrast Keynesians believe that when M increases it may be absorbed by a slowdown in V, so extra money is not spend on goods/services. There is no link between P and M as V can change significantly due to confidence changes
Expectations on changes in price levels
If people expect that the rate of inflation next year is going to be high, they will behave in an inflationary way and their behaviour will deliver high inflation next year. Trade unions and workers bargain for higher wages, and employers raise prices in anticipation of a higher expected inflation rate. Likewise when people expect the inflation rate to fall, they badge in a way that enables low inflation to be achieved so govs try to talk down the rate of inflation by convincing people that policies are credible to control inflation
Consequences of inflation
Fiscal drag
Distortion of behaviour- consumers can bring forward purchases or hoard goods if they expect accelerated inflation and businesses can do similar
Distributional effects- weaker social groups living on fixed incomes lose while those in strong bargaining positive gain, rising inequality
Money becomes less useful and efficient as a medium of exchange and store of value. Reduced international competitiveness. Reduced value of savings and real wages. Erodes debt: debt to GDP ratio is shrinking while debt is staying the same so repaying bond holders requires a smaller % of gov revenue
Malign deflation with cons
A lack of AD in the economy causing lower growth and increased cyclical unemployment.
Delayed spending (hope prices will fall further), Positive real interest rates as incentive to save and borrow less, Falling incomes which increases value of debt, lack of investment, lack of confidence
Benign deflation with cons
An increase in AS, this may be due to a fall in production costs from raised efficiency.
Lower prices, boosts consumer expenditure, boosts investment, boosts export demand causing higher AD, falling prices of FOP
Policies to reduce inflation
Contractionary monetary/fiscal policies ( decreased gov spending, increased tax, increased interest rates) but may conflict with growth/ employment.
Gov restricting wage rise, decreased corporation tax, subsidies, supply side policies, but may lead to inflexible labour market or promote inefficiencies
Index Numbers
A statistical technique for helping economists to interpret, analyse and compare large numbers. May be time-series data’s or inter-country comparisons . Index numbers compare year of country to a base year or country which is equated to a value of 100
Price Index
An index number showing the extent to which a price, or ‘basket’ of prices, has changed over a period of time, in comparison with a base time. Calculate: weights x price index percentages for each category. Add all figures together. Divide by 10
Unemployment Rate
Unemployed/Economically active (employed and unemployed) multiplied by 100. Sampling errors, cost, underemployed, productivity
Claimant Count
People who are claiming benefits. Difficult to compare between countries, not everyone will claim, not everyone can claim, could be subject to fraud
Purchasing Power Parity (PPP)
The exchange rate which equals the purchasing power of different currencies by eliminating the differences in price levels. Two currencies are in equilibrium when their currencies are at par when goods are priced the same while taking into account exchange rates.
Limitations of national income data
Exclusion of non market interactions. Errors in measurements. No measure of welfare (externalities). Changes in the quality of output.
Voluntary and involuntary unemployment
voluntary- an economic agent chooses to not work, either don’t want a low pay job or are satisfied with benefits.
involuntary- unemployed despite being willing and able to work
Types of involuntary unemployment
Frictional- temporarily out of work e.g. illness
Seasonal- work in seasons like summer only and then stop
Structural- jobs are removed, either relocate or retrain for new jobs
Cyclical- when the economy declines and people lose their jobs
The consequences of unemployment
Unemployment is a waste of human capital. When workers aren’t employed not all of the economy’s productive resources are used to produce output which could ,if produced, add to the standard of living and economic welfare, instead the economy produces inside its production possibility frontier rather than its potential. Unemployment also reduces international competitiveness, reduces incentives for firms to invest in new tech which generally leads to increased export competitiveness. Under-investment can also be caused by higher business taxes to help finance welfare benefits to unemployed. Erosion of job skills also makes unemployed less attractive long term so an economy can begin to behave as though it’s on its PPF even though there are plenty unemployed, an increase in AD may cause inflation rather than less unemployment. Although a certain amount of unemployment is necessary as it can reduce inflation and contributes to widening income differentials of better-paid and low-paid workers which can be a good thing in increasing incentive to work harder
Real wage unemployment
Unemployment caused by real wages being stuck above the equilibrium market wage, causing an excess in supply of labour
Natural rate of unemployment
Full employment does not mean everyone’s working, more so that the number of people wishing to work at the market wage rate equals the number of workers whom employers wish to hire at that wage rate. Frictional and structural unemployment make up equilibrium or natural unemployment.
Why Keynesian’s reject QTM
The velocity of circulation is not constant- monetarists believe that because money earns little or no interest it is generally rational to spend quickly on goods or non-money financial assets like shares but under certain circumstances (like when bond prices are expected to fall) it is logical to hold idle money balances to avoid capital losses which reduces money circulation.
Under-full employment equilibrium- argue there is spare capacity and unemployment in the economy, an increase of the money supply may increase real income and output
Consequences of deflation
When people believe prices are going to fall, they postpone high price consumption decisions e.g. buying a new car. They tend to cut demand, holding for better prices which can erode business confidence and trigger recession or prolong an already existing recession, but this assumes falling prices are a result of malign deflation. As consumers spend less, and save waiting for prices to fall, businesses will start to lose profits and reduce prices until they possibly collapse from no reduction in costs and economy growth stumbled exponentially.
The effect of world commodity prices on domestic inflation
Cost-push inflation often occurs from raising prices of imported food, energy and raw materials. The raised costs moves the burden onto consumers by raising prices which causes inflation. Therefore raises commodity prices can cause cost-push inflation
How do changes in other economies affect UK inflation
When times are good in the world economy, with rising demand for commodities and hence rising prices, the UK tends to import inflation from booming economies around the world. Prices of imported foods and raw materials increase, UK suffer import-cost inflation. Conversely when times are bad and other countries experience recessions, UK inflationary pressure is reduced. In the extreme, falling worldwide demand for UK exports can cause deflation but disinflation is more likely to occur and a fall in the pound’s exchange rate against other currencies contributes to imported cost-push inflation
How output gaps relate to unemployment and inflation
Assuming that inflation increases and unemployment falls when there is a growing positive output gap, and the opposite is the case with a growing negative output gap, the policy conflict between achieving these two policy objectives is greatest.
Policy conflicts with short run Phillips curve
Short run- argued statistical evidence showed a stable inverse relationship between rate of wage inflation and labour force unemployment. Both demand pull and cost push inflation can be used to explain, demand pull: the factor causing unemployment to fall and moving up the Phillips curve , is excess demand which pulls up money wages and average price level and cost push: falling unemployment means trade union power rises, enabling unions to push for higher wages. Phillips curve illustrates the conflict between full employment and control of inflation
Policy conflicts with long run Phillips curve
Rate of unemployment is at the natural rate, free marketists argue it is impossible to reduce unemployment below the nature level of unemployment, except at the cost of suffering and ever-accelerating rate of inflation or hyperinflation which can heavily damage the economy. This is because Keynesians ignored the influence of expected rate of inflation, if the gov increase AD with the aim of reducing unemployment below natural level, people revise upwards their expectations of future inflation causing higher current inflation which causes higher expectations and causes a loop.
Reconciling possible policy conflicts in short and long run
In short run, policy conflicts between reducing unemployment and achieving price stability may be reconciled in a highly depressed economy in which output is well below normal capacity. However if the economy is initially producing on its vertical LRAS curve and with unemployment at its natural level, short-run reconciliation is no longer possible. Instead gov should try improve supply-side conditions in economy in the hope of increasing labour productivity and making economy more competitive in world markets
Real and Nominal GDP
Real- Measure of all goods and services produced adjusted for price changes or inflation
Nominal- measured at current market prices without removing effects of inflation
Under-employment
A situation where an individual is working, but their job does not fully utilize their skills or abilities, and/or does not provide sufficient hours or pay to meet their needs.
