Economics Stage 5 Flashcards
What is Inflation in Economic Terms?
- Prices within an economy have a tendency to
rise over time. - This tendency is often referred to as inflation.
- Inflation is measured by indices.
- These indices takes a representative basket
of goods (and services) that are commonly
consumed in an economy and records how
their prices change over time. - Inflation figures in the UK are generally
reported monthly. - Inflation is connected to the value of money.
What is the Basket of Goods?
- The basket of goods used in the
calculation of inflation indices needs to
represent consumer spending patterns. - This basket is selected and regularly
updated by the ONS. - Household expenditure surveys are used
to assemble the basket and assign
appropriate weights. - New goods are introduced, existing
goods are removed, and weights are
revised as preferences change.
What are in the Inflation Indices?
- There are two common indices of inflation
applied in the UK:
▪ RPI– Retail Price Index.
▪ CPI– Consumer Price Index.
- The RPI was introduced after World War 2 as
a means to protect the purchasing power of
worker’s wages. - The CPI was introduced in 1996 by the Bank
of England as a international comparable
measure of inflation. - The BoE gained independence from the
Government in 1998 and was set a 2%
inflation target in 2003.
What is coverage and population base in relation to CPI?
Coverage is the actual goods and services included in the indices.
Population base is the expenditure, as covered by the index, and the source for the expenditure data.
How does CPI affect student loans and train tickets?
- The CPI is the UK Government’s official
measure of inflation. - The Government is inconsistent in its use of
the different rates on inflation.
▪ Student Loan interest rates are calculated
using the RPI (+3% dependent on
earnings).
▪ Regulated Train fares increase annually
based on the RPI.
▪ State Benefit such as the pension increase
with CPI.
What is International Trade?
- Nations trade with one another due to the occurrence of comparative advantage.
- This allows nations to specialise production in goods and services which they have a low opportunity cost.
- When a nation conducts international trade, it can:
▪ Export– sell goods and services and receive payment.
▪ Import– purchase goods and services and send payment.
The accounting of this international trade is referred to as the Balance of Payments (BOP).
What are the two components of the BOP?
- The BOP has two separate components, being the:
▪ Current Account– records the trade in goods and services, with imports being debits and exports being credits.
▪ Capital and Financial Accounts– record the flow of investment and money.
What is the Government Policy of the UK Gov?
- The UK Government acts as the primary steward for the economy and applies policy to control economic indicators.
- These indicators denote the health of the economy and cover:
▪ Promotion of long-term economic growth/expansion of real GDP.
▪ Stabilisation of the business cycle– avoid recessions.
▪ Attainment of full employment– reduce job seeking.
▪ Stabilisation of prices– low and predictable inflation.
▪ Reduction of current account deficit– promotion of exports.
▪ Reduction of government debt– limit budget deficits.
- Achieving these aims is thought to provide a suitable environment for sustained economic prosperity.
What is the Fiscal and Monetary policy of the UK Gov?
- These policies are often separated into two groups:
▪ Fiscal Policy– this represents the taxes the government levies of economic activity and how the government uses these receipts to fund public services.
▪ Monetary Policy– this represents the setting of interest rates and the supply of money in an economy.
- The government employs these economic policies
in order to:
▪ Stimulate activity during a downturn to avoid recession.
▪ Depress activity during an upturn to avoid overheating.
What are the Macroeconomic Indicators?
- The primary starting point of macroeconomics inquiry is to conduct measurements of the national economy.
- These measurements focus on aspects of economic performance such as:
▪ National Production– the overall size of the economy.
▪ Employment– the size of the workforce and the rate of unemployment.
▪ Inflation– the tendency of prices to increase.
- The dynamics of these measurements are of particular importance and their
interconnection:
▪ Economic Growth– the gradual expansion of production.
▪ Business Cycles– the tendency for periods of expansion and contraction in production.
- Economists have produced simplified models of the macroeconomy to illustrate these dynamics.
- One of the common models is referred to as the Aggregate Supply and Aggregate Demand (AS-AD) Model.
What is the Aggregate Price Level?
The aggregate price level is a measure of the overall level of prices in the economy.
- In the microeconomic part of the module, we covered the workings of demand and supply within a single market.
- This covered the relationship between the quantity demanded/supplied of a good and the price of that good.
- Aggregate Supply (AS) and Aggregate Demand (AD) concern the cumulative amount of supply and demand within an entire economy.
- One way to conceptualise this is that if you added up all the demand and supply within single markets you would calculate AD and AS.
What is Aggregate Demand?
The total demand for goods and services within a particular market.
- AD can be represented by an AD curve.
- This AD curve illustrates the relationship
between real GDP and the price level. - The price level represents the overall level of
price within an economy. - An increase in the price level is analogous to
the occurrence of inflation. - The AD curve is downward sloping, indicating
an negative relationship between real GDP and the price level. - This negative relationship is due to the:
▪ Wealth Effect.
▪ Interest Rate Effect.
What is the AD wealth effect?
- There is a movement along the AD curve from a higher point of the curve to a lower point of the curve (X axis being Real GDP and Y being Price Level).
- This occurs as the purchasing power of money
has increased. - As purchasing power increases, expenditure
on goods and services will also increase.
What is the AD interest rate effect.
- The economy starts at Point A, where real GDP is
£800 bn and the price level is 100. - The economy subsequently enters a inflationary
period, we move to Point B when the price level is
120 and real GDP is £700 bn. - As the price level rises (and incomes remain the
same), consumers need to spend more of their
household budget on goods and services. - This means the rate of saving within the economy
decreases. - As the rate of saving decreases, interest rates
increase (i.e. the cost of lending). - This reduces the level of investment within an
economy as borrowing has become more expensive.
What causes an AD curve to shift to the rightward?
▪ Expansion in Consumption– households
anticipate increases to income in the future
encouraging borrowing in the present.
▪ Expansion of Exports– household incomes in
trading partners increase.
▪ Expansion in Capital Investment– Manchester Airport expands to three runways.
