Economics 2.6

Question 1

What are the macro economic objectives

Answer 1

Economic growth
Low unemployment
Low and stable rate of inflation
Balance off payments equilibrium on current account

Question 2

What is economic growth in the UK

Answer 2

In the UK, the long run trend of economic growth is about 2.5%. Governments aim to have sustainable economic growth for the long run.

Question 3

What is low unemployment in the `uK

Answer 3

Governments aim to have as near to full employment as possible. They account for frictional unemployment by aiming for an unemployment rate of around 3%.

Question 4

What is low and stable rates of inflation in the UK

Answer 4

In the UK, the government inflation target is 2%, measured with CPI. This aims to provide price stability for firms and consumers, and will help them make decisions for the long run.

Question 5

What is the balance of payments equlilbruim on current account in the UK

Answer 5

Governments aim for the current account to be satisfactory, so there is not a large deficit. This is usually near to equilibrium.

Question 6

What are some of macro economic objectives that do not relate to improving the economy

Answer 6

• Balance of government budget
• Protection of the environment
• Greater income equality

Question 7

What is the government budget

Answer 7

This ensures the government keeps control of state borrowing, so the national debt does not escalate. This allows governments to borrow cheaply in the future should they need to and makes repayments easier.

Question 8

What is protection of the environment

Answer 8

This aims to provide long run environmental stability. It ensures resources used are not exploited, such as oil and natural gas, and that they are used sustainably, so future generations can access them too. Moreover, it means there is not excessive pollution.

Question 9

What is greater income equality

Answer 9

This minimises the gap between the rich and poor. It is generally associated with a fairer society.

Question 10

What are the governments demand side policies

Answer 10

Demand side policies are policies designed to manipulate consumer demand.

Question 11

What are some key demand side polices

Answer 11

• expansionary policy
• deflationary policy
• monetary policy
• fiscal policy

Question 12

What is expansionary policy

Answer 12

This aims to increase AD and bring about growth

Question 13

What is deflationary policy

Answer 13

This attempts to decrease AD to control inflation

Question 14

What is monetary policy

Answer 14

This is where the central bank or regulatory authority attempts to control the level of AD by altering base interest rates or the amount of money in the economy.

Question 15

What is fiscal policy

Answer 15

This is the use of borrowing, government spending and taxation to manipulate the level of aggregate demand and improve macroeconomic performance.

Question 16

What are the three main areas where monetary polices are used

Answer 16

• Interest rates
• Monetary supply
• the role of the Bank of England

Question 17

How are interest rates used as part of monetary policy

Answer 17

The interest rate is the price of money and the MPC are able to change the official base rate in order to tackle inflation. This is called the ​repo rate​,

Question 18

How is a change in the repo rate able to effect interest rates

Answer 18

A change in the repo rate affects market rates offered by banks to consumers and businesses as the Bank of England is the lender of last resort. If they are short of money, they will have to borrow from the Bank at the repo rate and therefore they need to make sure that their interest rates are based on this rate so that they are able to make a reasonable return.

Question 19

What are the mechanisms a rise in interest rates causes a fall in AD

Answer 19

• An increase in the cost of borrowing
• savings are more attractive
• value of the pound rising
• less confidence

Question 20

How does an increase in the cost of borrowing lower AD

Answer 20

This will lead to a fall in investment and consumption, reducing AD. Two particular areas of consumption that will decrease are consumer durables and houses. Higher interest rates require higher rates of return for investment. It also makes ​savings more attractive​, as the interest earnt on them will be higher.

Question 21

How does saving becoming more attractive decrease AD

Answer 21

Since less people are borrowing and more are saving, there is a fall in demand for assets such as stocks, shares and government bonds. This leads to a ​fall in prices for these assets​. Therefore, consumers will experience a negative wealth effect since the value of their assets fall, which will lead to a fall in consumption. Moreover, investment is less attractive since firms are likely to see lower profits if prices fall. AD falls because of the fall in consumption and investment.

Question 22

How does people becoming less confident decrease AD

Answer 22

The fall in consumer and business confidence leads to a fall in consumption and investment, causing a fall in AD. On top of this, other loans, such as mortgages, will become more expensive to repay and so consumers have to dedicate more of their income to paying back these debts. This means they have less income to spend on goods and services, so consumption will fall, causing AD to fall.

Question 23

How does the value of the currency rising decrease Ad

Answer 23

This means that imports will be cheaper, and exports will be more expensive. This decreases net trade and therefore AD.

Question 24

What are some problems with monetary policy of demand management

Answer 24

Firstly, the exchange rate may be affected so much that exports fall significantly and
imports rise significantly, causing a ​balance of trade deficit​.

Sometimes, ​interest rates are so low that they cannot be decreased any further to stimulate demand. This is a particular issue for many countries today, and something
most people never thought would be a problem.

High interest rates over a long period of time will ​discourage investment and
decrease LRAS.

Question 25

What is quantitative easing

Answer 25

This is when the Bank of England ​buys assets in exchange for money ​in order to increase money supply and get money moving around the economy during times of very low demand.

Question 26

How does quantitative easing have the effect of ensuring country’s meet their inflation target

Answer 26

• Since the bank is buying assets, there is a rise in demand and so ​asset prices rise​. This causes a positive wealth effect since shares, houses etc. are worth more so people will increase their consumption.
• Moreover, the ​money supply increases​. Private sector companies receive more money which they can spend on goods and services or other financial assets, which may increase investment or consumption and therefore increase AD.
• Commercial banks may ​lower their interest rates as they are receiving so much money from the Bank of England and so can offer very low interest deals to their customers. The increased money supply will mean that the price of money falls; interest rates are the price of money.

Question 27

What are some of the problems with quantitative easing

Answer 27

• It is very risky and, if not controlled properly, could cause high inflation and even
  hyperinflation.
• Others say it would only lead to increased demand for ​second hand goods which
  pushes up prices but does not increase aggregate demand. For example, it would not lead to more new houses being built but only second hand houses becoming more expensive.
• There is ​no guarantee that higher asset prices lead into higher consumption through the wealth effect, especially if confidence remains low.

Question 28

What is the role of the Bank of England in monetary policy

Answer 28

The Bank of England controls the monetary policy committee.

Question 29

What is the aim of the Bank of England

Answer 29

The aim is for them to keep inflation at 2% and if it goes above by one of below the governor has to explain why and how they are going to bring this back on target

Question 30

How can fiscal policy change AD

Answer 30

• A rise in income tax will cause a fall in disposable income. This will lead to a reduction in consumption and thus decrease AD.
• rise in ​government spending​ will increase AD since it is one component.

Question 31

What is the governments budget

Answer 31

The government’s fiscal (spending, borrowing and taxation) plans are outlined in the budget.

Question 32

What is a budget deficit

Answer 32

A ​budget deficit is when the government spends more money than they receive.

Question 33

What is a budget surplus

Answer 33

A ​budget surplus​ is when the government receives more money than they spend.

Question 34

What are direct taxes

Answer 34

Direct taxes are paid directly to the government by the individual taxpayer.

Question 35

What is indirect tax

Answer 35

An ​indirect tax is where the person charged with paying the money to the government is able to pass on the cost to someone else

Question 36

What are some of the problems with fiscal policy

Answer 36

• Government spending also ​impacts LRAS​. For example, by cutting government spending to reduce AD, the government may be reducing the quality of education or spending on research and technology.
• Taxes and spending have an impact on ​inequality​, so some decisions aimed to
  reduce/increase demand may increase income inequality. They also have an impact on ​incentives​, for example high taxes reduce incentives.
• The government also has to worry about ​political issues​, for example they may be unwilling to raise taxes in order to reduce demand as this may lead to them being voted out of government

Question 37

What are some of the issues of demand side polices

Answer 37

• Classical economists argue that any demand management, whether fiscal or monetary, will have ​no effect on long-run output so supply side policies should be used.
• Both policies see significant ​time lags ​between their introduction and their full effect.
• The biggest issue of demand-side policies is that, in most cases, an expansionary policy is ​inflationary whilst a deflationary policy brings ​unemployment​.

Question 38

Why may monetary policy be favoured over fiscal policy

Answer 38

Monetary policy is useful as the government is able to increase demand without having to increase their spending, which would result in a larger fiscal deficit. Classicists argue that if demand management is going to be done only monetary policy should be used.

Question 39

Why may fiscal policy be favoured over monetary policy

Answer 39

Fiscal policy can have significant impacts on the supply side of the economy, for example increases in spending on education to increase AD will also increase LRAS. Moreover, it is more effective at targeting specific groups and reduce poverty, for example by increasing benefits it can increase AD and reduce inequality.

Question 40

What was the cause of the Great Depression

Answer 40

Wall Street Crash of 1929

Question 41

What are some alternative beliefs about what started the Great Depression

Answer 41

• Firstly, it may have been caused by the ​loss of consumer and business confidence​
• Moreover, it could have been caused by the ​US banking system​. Banks had lent too much during the 1920s, which had created an unsustainable boom and the system was unable to deal with issues following the crash
• Protectionism may also have been another cause of the Great Depression. It reduced world trade which decreased AD and lowered confidence
• The UK was also affected by its commitment to the ​gold standard, in which its currency was fixed to the value of gold and therefore fixed to other currencies. The rejoining of the gold standard meant the pound was appreciated rapidly and exports fell as they became more expensive. The UK went into the Great Depression with an overvalued exchange rate.

Question 42

What was the UK’s response policy to the Great Depression

Answer 42

• The UK government believed that ​balancing the government budget was key to recovery and that borrowing money would prevent the private sector from doing so. They introduced an emergency budget which ​cut public sector wages and unemployment benefit ​by 10% and ​raised income tax from 22.5% to 25%. This reduced AD at a time when it needed to be increased
• A balanced budget meant the UK didn’t have to borrow from abroad, which helped the exchange rate as did the high interest rates used to defend the high exchange rate. However, the ​high interest​ ​rates​ also decreased demand.
• This caused the value of the pound to fall by 25% compared to other currencies and allowed the Bank of England to ​cut interest rates by 2.5%, both of which helped the increase AD by increasing exports or increasing consumption/investment.

Question 43

What was the cause global financial crisis in 2008

Answer 43

The 2008 crisis was started by issues in ​mortgage lending in the USA. In the early 2000s, relatively poor people were encouraged by the government and banks to take out mortgages to buy their own homes. This was an example of moral hazard, as the bank workers saw higher bonuses for selling more mortgages. They were given low interest rates on the loan for the first few years, but many were no longer able to continue paying with the higher repayments. Houses were repossessed, demand fell, and prices fell meaning the value of the houses was now less than the mortgage of the house. This is known as negative equity.

Question 44

What where prime and sub prime mortgages during the run up to the global financial crisis

Answer 44

banks had been ​grouping ‘prime’ mortgages (people who were likely to pay back their loans) ​and ‘sub-prime’ mortgages (those who weren’t) and selling packages to other banks and investors as if they were all prime mortgages.

Question 45

Why did the sub-prime morgages increase banks risk

Answer 45

it increased risk as many were now holding assets worth less than they had paid for them; it spread the effects of the housing crash and the unpaid loans.

Question 46

Why did banks stop lending money to each other during the 2008 financial crisis

Answer 46

there was a ​fall in confidence and banks stopped lending between each other, fearing that they would lose money if the other bank were to collapse.

Question 47

What was the response of the governments in USA and UK to the global crisis

Answer 47

Both governments were forced to ​nationalise banks and building societies and guarantee savers ​their money in order to prevent the chaos of a collapsed banking system.

They used ​expansionary monetary policies with record low interest rates and quantitative easing.

Question 48

What are supply side policies

Answer 48

Supply side policies are government policies aimed at ​increasing the productive potential of the economy and moving the supply curve to the right

Question 49

What are market based policies

Answer 49

Market based policies are policies which are designed to remove anything that prevents the free market system working efficiently, causing lower output and higher prices.

Question 50

What are some examples of market based policies

Answer 50

These barriers include those which reduce willingness of workers to take jobs or lead to inefficient production, high prices or a lack of risk-taking.

Question 51

What are interventionist policies

Answer 51

Interventionist policies are policies designed to correct market failure

Question 52

What are some examples of interventionist policies

Answer 52

the free market under provides education and so the government provides it. Also, firms may only look into the short term and look to maximise short run profits to give to shareholders instead of investing, so governments may take actions to encourage investment.

Question 53

How does increasing incentives policies aim to accomplish

Answer 53

By increasing the incentive for people to go to work or firms to employ people, the government will increase the ​size of the workforce and this would mean more goods and services would be produced.

Question 54

What are some of the policies which increase incentives

Answer 54

A ​reduction in benefits/taxes will increase the opportunity cost of being out of work and mean that people are always better off within work than on benefits. This is why the government have introduced ​Universal Credit​, which helps to ease the transition into and out of work.

Question 55

What is the poverty/unemployment trap

Answer 55

where low income workers end up in the same or an even worse position after they gain a new job because of the benefits they lose.

Question 56

What is come issues of increased incentives

Answer 56

Reductions of tax on high income earners will lead to more income inequality and any reduction will mean governments have less revenue so have to decrease spending or borrow more. Reducing benefits will also worsen equality.

Question 57

How does the policy to promote competition work

Answer 57

It is split into privatisation and competition

Question 58

How does privatisation work

Answer 58

Privatisation, selling nationalised companies to private sectors, or ​deregulation​, reducing restriction on businesses which restrict entry to the market, makes firms more competitive.

Question 59

How does competition work

Answer 59

Competition ​policy is used to prevent monopolies in the market and make cartels and price fixing agreements illega

Question 60

Why is the completion policy in place

Answer 60

The belief is that competition is necessary to make firms efficient as they have to offer a cheaper or better service if there is competition.

Question 61

What are some polices which are used inorder to reform the labour market

Answer 61

• By ​increasing the retirement age​, there will be more people working and so more goods and services could be produced.
• If the ​minimum wage is set above the equilibrium level it will cause increased unemployment, so some people argue the minimum wage should be scrapped to prevent real-wage inflexibility unemployment.
• The ​reduction of benefits will also increase incentive to work and help to reform the labour market. ​Universal Credit is helping to reform the labour market, although it is currently experiencing problems in setting it up.

Question 62

What is effect of trade unions on the labour market

Answer 62

Trade unions push up wages which can lead to businesses laying off some workers and reducing production, which limits AS, and so therefore reducing their power will hope to prevent this.

Question 63

Why could weakening trade unions be an issue for AS

Answer 63

On the other hand​, trade unions are already very weak in the UK so reducing their power further may have little effect. Similarly, reducing benefits will lower AD if these people are unable to get jobs and this will cause a further fall in employment

Question 64

Why could reducing trade unions power be pointless

Answer 64

trade unions are already very weak in the UK so reducing their power further may have little effect. Similarly, reducing benefits will lower AD if these people are unable to get jobs and this will cause a further fall in employment

Question 65

What are some polices around improved skills that could improve quality of the labour force and therefore AS

Answer 65

• They could ​increase spending on education and training ​to create a more educated workforce who will be more efficient and be able to do more skilled jobs, increasing the number of goods and services produced.
• they could introduce ​regulation ​which forces businesses to continuously train their own staff, to keep them up with development
• An ​increase in high skilled migrants ​would also improve the quality of the workforce.

Question 66

Why would improving the work force increase AS

Answer 66

improvements in skills will mean that workers are ​more efficient ​and so can produce more goods and services as well as being more skilled so be able to develop new technology

Question 67

Why could improving education not have an effect on As

Answer 67

improving education may have no effect if it is in skills not relevant to the workforce. Increasing education will incur an opportunity cost as it means government money will be lost in other sectors.

Question 68

How could polices be created to improve infrastructure

Answer 68

• This could be done through offering ​tax incentives or subsidies on investment.
• the ​government could spend money to improve infrastructure themselves.

Question 69

Why would the government use polices to improve infrastructure in order to increase AS

Answer 69

This will mean new technology will be developed and more will be invested in buying new technology. Improvements in technology will mean that production is ​more efficient so less resources are needed to produce the same amount of goods whilst more technology will mean more goods and services can be produced.

Question 70

What are some issues with using polices to improve infrastructure In order to improve AS

Answer 70

Offering tax breaks/subsidies could have adverse effects on the government budget as it will mean they lose tax revenue or incur an opportunity cost as they have to spend money on subsidies. Some businesses may not actually invest this money and instead used it as a method of tax evasion.

Question 71

What are some issues with supply side polices as a whole

Answer 71

• no impact when LRAS is elastic​, and so demand-side policies are needed to fix the problem in the short run.
• not all supply side policies work at actually increasing supply, whilst others cause conflicts and both these issues vary depending on which policies are used.
• the government has to spend more money (for example on education) or decrease taxes, which will decrease their revenue and lead to a ​budget deficit​.
• These actions may also have ​undesirable impacts on AD and could cause higher unemployment or higher inflation.

Question 72

What are some of the benefits of supply side polices

Answer 72

• Unlike demand-side policies, supply side policies are able to both ​increase output
  and decrease prices​
• They are more ​long-term policies and lead to long term economic growth, rather
  than small changes in economic growth following changes in AD.
• they can be directed at increasing exports which will also ​improve the
  balance of payments.

Question 73

What are some conflicts and trade-offs between objectives and polices

Answer 73

• Economic growth VS protection of the environment
• Economic growth VS balance of payments
• Unemployment VS inflation

Question 74

What is the conflict between economic growth policy and protection of the environment

Answer 74

​As the economy grows, we expect more resources to be used. As we use resources and produce goods, we produce pollution and noise and destroy habitats.

Question 75

What is the conflict between economic growth VS balance of payments

Answer 75

​Some countries such as ​India have seen rapid economic growth leading to balance of payments problems. The country is so large that its industry is largely producing goods for its own people and the wealth of the people has led to increased demand for imported goods.

Question 76

What is the conflict between unemployment VS inflation

Answer 76

which said that the rate of change in money wages increased as the rate of unemployment fell. This was then generalised into a relationship between unemployment and inflation, by arguing that firms pass on increases in wages to the customer in increased prices. The reason for this connection is that businesses know that if there is a high level of unemployment, they can attract the workers they want with low wages. If there is high employment, firms are competing for the best workers and the way to obtain the best is by offering higher wages.

Question 77

Draw the Philips curve

Answer 77

Check psy math tut

Question 78

What are some trade offs and conflicts between policolices

Answer 78

• expansionary and deflationary fiscal and monetary policies
• changes in interest rates
• supply side policies
• fiscal defects

Question 79

What are conflicts between expansionary and deflationary fiscal and monetary policies

Answer 79

Expansionary policies will increase AD, to increase output, employment and economic growth but will lead to increased inflation and may worsen the balance of payments as some of the increased demand for goods and services will be met by imports. On the other hand, deflationary policies will decrease AD to improve inflation but will decrease employment and economic growth.

Question 80

What are some conflicts between changes in interest rates

Answer 80

​An increase in interest rates will be used to decrease inflation. However, continuously high rates will damage long-term investment as less businesses will want to invest, and this will decrease long-term growth. Moreover, they will raise the value of the pound which will decrease exports and increase imports, worsening the balance of payments. Also, the interest rate will affect distribution of wealth: high interest rates benefit savers and lenders, tending to be older people as they are more likely to have savings. Low interest rates tend to increase income inequality, as the richest people hold a larger proportion of their wealth in non-money assets, such as stocks, shares and belongings and so aren’t affected much by interest rates, whilst middle and working-class people are more likely to have savings in the bank.

Question 81

What are some conflicts between supply side policies

Answer 81

Supply side policies intend to increase aggregate supply, and therefore improve long term economic growth. They are also able to decrease long term inflation but may increase it in the short term if they encourage investment as this will increase AD. Moreover, policies which decrease trade union power, reduce wages, lower benefits, change taxation etc. may increase income equality as these will negatively affect the poorest in the country. Some supply-side policies have adverse effects on the budget or on the environment.

Question 82

What are some conflicts between fiscal deficits

Answer 82

In order to reduce fiscal deficits, the government may decide to reduce government spending and increase taxes. Firstly, this will reduce AD and decrease short term economic growth and higher unemployment. Also, the higher the fall in output as a result of these measures, the higher the fall in tax revenues will be and so therefore the more ineffective the policy. Moreover, it is likely to affect income equality as the poor are the ones who use the government services most and so will be worst affected.