Economics Theme 2 Flashcards
How is economic growth measured? (short and long run)
Short-run economic growth is measured by the annual percentage change Real GDP.
Can also be measured by percentage change in Gross National Income (GNI) or Gross National Product (GNP).
Long-run economic growth is measured by the increase in potential output from the increase in the productive capacity of the economy. This is also called Potential Economic Growth
What is the difference between nominal and real values?
A nominal value is expressed in monetary terms, so doesn’t take into account inflation.
A real value is adjusted for inflation.
What is the difference between total and per capita?
Total is all the values added up.
Per capita is the total divided by the population to show the average per person.
What is the difference between volume and value?
Volume looks at the quantity of goods and services produced.
Value looks at the monetary worth of goods and services produced.
What is GDP?
The total output of goods and services within the geographical boundaries of a country.
Components: C+I+G+(X-M)
(Consumption, Investment, Government spending, Exports, Imports)
What is GNP?
Gross National Product
Value of all goods and services produced by domestic businesses, including abroad.
What is GNI?
Gross National Income
The total level of formal income in a country, but doesn’t include informal income.
What 2 things can the rate of economic growth be compared to?
The rate of growth over time
The rate of growth in other countries
What is the difference between income and wealth?
Wealth measures the value of income and assets that have been accumulated over time.
Income measures the amount of money that has been obtained over a given interval of time.Income represents the addition to wealth over time.
Income is a flow, wealth is a stock.
What is Purchasing Power Parity and how is it used?
PPP exchange rates are designed to reflect how much can be purchased with a certain income in different countries.
It takes into account the fact that the cost of living is higher in some countries than others, so the purchasing power is not equal
Using the real exchange rate tends to overstate incomes for high-income countries and understate for low-income countries
What are the limitations of using GDP to compare living standards between countries and over time?
GDP per capita is an average - it takes no account of inequallity, so it could be possible that many are worse off than the average figure
The informal sector and underground economy - Some output of goods and services is deliberately not declared to avoid tax or if it is illegal
Subsistence, barter, charity and DIY - GDP only includes goods and services that are exchanged for money
Doesn’t take into account changes in quality over time or variance in quality between countries - Figure is midleading
Doesn’t take into account externalities
Figures are sometimes revised later on (because complicated process)
Why does the government research UK national wellbeing? What is the relationship between incomes and happiness?
Money doesn’t necessarily buy happiness, so the government researches national wellbeing (how happy a person perceives themself to be). There is a clear relationship beween income and happiness because poverty and debt can be demoralising, whilst high-income gives freedom and higher status. Happiness is important because happier people require less healthcare, are more productive, commit less crime and contribute more to society.
Why might happiness not be a useful indicator for governments?
Happiness is vague and complex, and difficult to define and measure.
It can’t be quantified because it is a qualitative concept.
Many economists believe that after a certain level of income, an increase in income doesn’t correlate to an increase in happiness.
Inflation, deflation and disinflation definitions
Inflation is a sustained rise in the price level.
Deflation is a sustained fall in the price level.
Disinflation is a decrease in the rate of inflation.
How is the UK inflation rate calculated using Consumer Prices Index (CPI)?
There are two surveys - one about what people buy and the other about how much the prices of these goods and services have changes.
The first survey is used to produce a basket of goods which shows the typical products UK consumers buy. It is weighted to take into account that some items have a greater efffect on the cost of living.
The second survey collects quoatations for these products from accross the country every month to see how much the prices have changed. The percentage change is multiplied by its weighting and the inflation rate is an average of all the percentage changes.
What are the limitatons of CPI in measuring the rate of inflation?
CPI doesn’t take into account changes in quality. E.g. A computer is more expensive than 20 years ago, but also much higher quality.
Changes in expendature can happen quickly as new products become available, but the baskets and weights are reviewed only once a year.
Potential sampling error as not all households respond to the survey or complete it accurately.
What are the main differences between CPI and RPI?
Population base - RPI exludes very high and low income households
Housing costs - CPI exludes owner-occupied housing costs
Formulae - CPI uses a combination of geometric and arithmetic means, whilst RPI only uses arithmeitc means
CPI is used by other countries too, so inflation can be compared between countries
Why does an increase in aggregate demand lead to demand-pull inflation and a decrease in aggregate supply lead to cost-push inflation?
If AD increases because of greater consumption, investment, government spending or next exports, the equilibrium moves up the LRAS curve, pushing against the limits imposed at full employment, and increasing the price level.
If AS increases because of an increase in the price of raw materials, wages, taxes etc, costs increase for businesses and they are forced to raise their prices, which increases the price level.
An increase in the money supply can also cause inflation if there is too much money chasing too few producers.
What are the effects of inflation on consumers, firms and governments?
International costs - if domestic products increase in price faster than other countries, products will becom less competitive
Real incomes - fall faster when inflation increases faster. Increase wages will fuel further inflation
Uncertainty - future costs are harder to predict, which deters investment
Search costs - prices are changing more often so firms spend more times looking for the best prices
Debt - real value of debt is eroded
Savings - real value of savings are eroded (young tend to benefit and old tend to suffer)
Menu costs - prices become out of date and need to be updated. E.g. cost of producing new catalogue/menu
Prevents deflation - worse effects arguably if deflation happens
What are the 2 measures of unemployment?
The claimant count
UK labour force survey
What are some of the problems with the Claimant Count?
Not everyone who is eligible signs on (Self-employed who are temporarily unemployed tend not to claim, social stigma)
Under 18s and over retirement age don’t can’t claim
Some people who claim aren’t actively seeking work
Some people have jobs in the underground economy but continue to claim
What are some of the problems with the Labour Force Survey? Why is it better than the Claimant Count?
Costly to compile
Subject to sampling and extrapolation errors
Internationally recognised - compare between countries, standardised methology across EU
Potential analysis of data (multiple interviews over time)
Picks up trends in sectors - better guide for policy makers
What is underemployment and what are some examples?
Underemployment refers to where people are employed but their job is insufficient.
Can only find part-time work when want to work full-time
Overqualified so not using all skills and abilities
Overstaffing - businessses employ workers who are not fully occupied, may be reluctant to make them redundant (avoid redundancy costs, avoid training costs when demand picks up again), workers may acceot wage freezes or cuts
What is the difference between unemployment and underemployment?
Unemployment occurs when workers are looking for work but can’t find a job.
Underemployment occurs when workers can’t find a job that is suitable to their qualifications or experience, or when workers want but cant find a full-time job, so settle with a part time-job.
What are the consequences of high unemployment for individuals and firms?
Individuals:
Loss of earnings
Lower standard of living
Loss of work skills (which decreases chances of being employed in future)
Worse health, lower life expectancy, depression
Firms:
Less demand and fall in consumption (unless inferior goods)
Downwards pressure on wage demands
Reduced morale and productivity (people are concerned about potential job loss)
What are the consequences of high unemployment for the government?
Lost tax revenue
Increase in government spending (automatic stabilisers)
Increased budget deficit
Increase in crime
Less output, therefore less economic growth
Economically inactive definition and examples.
Economically inactive people are people aged between 16 and the retirement age who are neither employed or actively seeking to become employed.
E.g. students, long-term sickness, early retirement, looking after family, discouraged from working
What are the 4 causes of unemployment?
Structural
Frictional
Seasonal
Cyclical
Structural unemployment definition and fixes.
Structural unemployment occurs when there is a long term decline in one industry, so the structure of the economy no longer matches the skills of the workforce.
It is caused by immobility of labour and can be fixed through education and training, improving labour market flexibility or enhanced geographical mobility.
Frictional unemployment definition, examples and fixes.
Frictional employment occurs when people move between jobs,
E.g. newly redundant, recently graduated
Flexible employment contracts, improved knowledge of jobs to reduce search times, changes to welfare payments to create a higher incentive to search for work
Seasonal unemployment definition and fixes.
Seasonal unemploymentoccurs when people are unemployed at particular times of the year when demand for labour is lower than usual.
Greater economic diversification, improve range of skills of workers (so can do multiple jobs at once)
Cyclical unemployment definition and fixes. (Also called demand deficiency unemployment)
Cyclical unemployment isunemployment that results directly from cycles of economic upturn and downturn.
E.g. During a recession there is less demand and higher costs, so businesses make workers redundant or shut down.
Lower taxes, lower interest, subsidies
Why does real wage inflexibility lead to unemployment?
Real wage inflexibility occurs when real wage rates are above the equilibrium wage rate. It causes the supply of labour to be greater than the demand for labour, and this causes unemployment because businesses won’t want to hire as many workers as it is more expensive than usual.
In a free market, the real wage rates would fall and the market would return to equilibrium, but because of the minimum wage and trade unions, wages are able to maintain an above-equilibrium rate.
What is the significance of migration and skills for employment and unemployment?
Migrants are usually of working age, so the supply of labour increases with more migration.
There could be more competition to get a job due to the rise in the size of the
working population.
Migrants who bring high-quality skills to the workforce, increase productivity and the skillset of the labour market. This could inrease global competitiveness.
Migrants can fill in skill shortages (plumbing, engineering, building)
Migrants often come from economies with lower average wages than the UK minimum wage, so will be happy to work at the minimum wage. This brings down wages in low-skill industries.
What factors influence unemployment?
School leaving age
Percentage of school leavers entering higher education
Level of net-migration
Level of taxes (income tax and national insurance)
Level of benefits
Minimum wage
Availability of jobs
What are the 3 components of the balance of payments?
The current account
The capital account
The financial account
What are the 4 parts of the current account?
Trade in goods
Trade in services
Primary income
Secondary income
What is the difference between a current account surplus and deficit?
The balance of payment usually balances out, but the current account can run a surplus or deficit. A deficit occurs when the amount of money leaving the economy in the 4 components of the current account is greater than the money coming into the economy. A surplus occurs when there is more money coming into the economy than leaving it.
Why does the UK run a deficit on trade in goods?
Large demand for consumer goods (that have to be imported)
Decline in manufacturing sector / outsourcing / global shift
Why does the UK run a surplus on trade in services?
Shift away from primary and secondary towards tertiary
UK more competitive globally with services
London is one of the main global financial centres
What is primary income in the current account?
Primary income is the net flow of profits, interest and dividends from investments in other countries and net remittance flows from migrantworkers.
What is secondary income in the current account?
The redistribution of income through current transfers by governments, multinational organisations or charities. This includes spending and transfers on foreign overseas aid, and payment to multinational bodies.
What is the relationship between the current account and productivity, inflation, exchange rates, economic activity in other countries, interest rates and consumer spending
Increase in productivity / Decrease in inflation - will reduce costs of production for firms, making them more competitive globally, and boosting exports.
Exchange rates - Appreciation will make exports more expensive for other countries and imports cheaper for the UK. Depreciaton will boost exports and reduce imports.
Economic activity in other countries - Economic growth could increase demand for UK products in those countries. Could also become more productive, so more competitive and reduce demand for UK products globally.
Interest rates - Low interest rates will encourage investment, and could boost primary income if it is from abroad. High rates could encourage firms to invest abroad instead, reducing primary income.
Consumer spending - Increase in consumption of imported products will boost imports.
What are the causes of a current account deficit?
High levels of income (people spend more on imports)
Recession in economies of trading partners (less demand for exports)
Overvalued exchange rate (Exports more expensive so less competitive, imports cheaper, so increased demand)
Low productivity (Uncompetitive products)
Poor non-price competitiveness (less demand)
Protectionism (harder for countries to export to UK, possible retaliation protectionist policies reducing imports from UK)
When is a current account deficit not a problem?
Short-term deficits
If it can be easily financed (e.g. investment inflows on financial account)
If caused by imports of raw materials that will be used to produce exports
If a small percentage of GDP
How can a government improve its current account deficit?
Reduce consumer spending (reduce imports)
Invest in supply side of the economy (improve productivity)
Depreciate the exchange rate (increase exports, decrease imports)
Improve overall macroeconomic conditions to encourage investment and growth of domestic industries
How do economies become more interconnected through international trade?
Economic activity in one country has a significant impact on another economy. E.g. incomes, productivity, inflation and the exchange rate can change the level of demand for imports and exports. Impacts the balance of payments, and therefore the performance of the economy.
What are the components of aggregate demand?
C + I + G + (X-M)
Consumption, Investment, Government spending, Imports and Exports
What is the difference between a movement along and a shift in the AD curve?
Movements along the curve are caused by changes in aggregate demand caused by changes in the price level.
Shifts of the curve are caused by changes in aggregate demand caused by changes in a variable other than the price level.
What is disposable income and how does it influence consumer spending?
Disposable income: The amount of money consumers have after the addition of state benefits and deduction of direct taxes.
It can change if taxes, benefits or wage rates change.
Higher levels of disposable income will normally lead to greater levels of consumption as individuals can afford more goods and services.
What are interest rates and how do they influence consumer spending?
Interest rates tellyou how high the cost of borrowing is and how high the reward for saving is.
Lower interest rates will normally increase consumption as saving becomes less attractive, and people spend or invest their money instead. Loans become more affordable and individuals with variable rate martgages see monthly disposable income increase.
What is consumer confidence and how does it influence consumer spending?
Consumer confidence isan economic indicator that measures the degree of optimism that consumers have regarding the overall state of a country’s economy and their own financial situations.
It is linked to consumers’ employment and the state of the economy
There is more consumer spending when there is higher consumer confidence as consumers are more certain of their financial prospects.
What are wealth effects and how do they influence consumer spending?
The wealth effect is abehavioral economic theory suggesting that people spend more as the value of their assets rise and spend less as the value of their assets fall. Positive and Negative wealth effects.
What is the difference between gross and net investment?
Gross investment is the total amount that the economy spends on new capital.
Net investment is gross investment – capital depreciation.
E.g. Firm needs to replace 10 cars but buys 12 cars. Gross investment is 12 cars. Net investment is 2 cars.
How does the rate of economic growth influence investment?
When there is a fast rate of economic growth, capitaldeteriorates faster because production is higher. More capital will require replacement, so investment will increase. Firms will also be making higher profits so they will more easily be able to afford this.
What is business expectation and confidence, and how does it influence investment?
Business confidence relates to the degree of optimism regarding the current business climates and the expected business condition in the future.
If firms are confident in future economic prospects and the likelihood of consumption increasing, they are more likely to invest in capital projects.
What is “animal spirits”, and how does it influence investment?
“Animal spirits” is a term created by Keynes to describehow markets and the economy are influenced by human behaviour and psychology
There is often more of a herd mentalitiy than a rational assessment of the situation. There will be more investment by individual firms when lots of other firms are investing, and less investment when few firms are investing, regardless of the true state of the economy.
How does demand for exports influence investment?
When there is higher demand, firms are encouraged to invest in capital assets in order to increase capacity to meet demand.
How do interest rates influence investment?
Lower interest rates mean that the cost of borrowing money is lower, so investment projects become less costly, which stimulates investment.
High interest rates increase the cost of borrowing money, which makes investment projects more expensive and lowers the rate of return to an insufficient level where it isn’t profitable.
How does access to credit influence investment?
Many businesses aren’t making supernormal profits, or enough supernormal profits to self-finance investment projects, so they require credit, such as in the form of a loan. However, some businesses struggle to access credit, which will prevent investment.
If businesses are easily able to access credit there will be more investment in the economy.
How does the government and regulations influence investment?
Laws, policies and regulations make it easier / more difficult / cheaper / more expensive to invest.
E.g. Grants and subsidies give firms funding to invest
Reducing planning permission regulations will make it easier for firms to build factories or invest in property to increase output
Reducing corportation tax will lower costs for business, giving them higher profits to invest
What is the Trade Cycle, and how does it influence government expenditure?
The Trade Cycle shows variations in the level of trade activity over time.
During times of economic growth there is less unemployment so the government will spend less on JSA payments and other benefits. The government will also receive more tax revenue during this time. During a boom period the government might decrease spending to reduce inflation or pay off debt.
When there is weak growth or a recession, the government will automatically have to spend more on JSA payments, and government tax revenue will decrease. There will likely be a short-term budget deficit. These automatic changes in government spending are known as automatic stabilisers. The government might inject money into the economy to increase AD. This would have a multiplier effect that would help to stimulate the economy.
How do real incomes influence the net trade balance?
As consumers’ real incomes increase demand for goods and services rise. This will lead to increased demand for imports because the UK has a high marginal propensity to import.
How do exchange rates influence the net trade balance?
An appreciation of the exchange rate will make UK exports less competitive, which will decrease demand for exports. Imports will also become cheaper for consumers, so demand for imports will increase.
How does the state of the world economy influence the net trade balance?
If there is a recession, inflation, high unemployment etc in another country, consumers in that country will have less disposable income, so be forced to spend less on imports, and demand for UK exports will.It will also impact the exchange rates, causing UK goods to become more or less globally competitive.
Strong economies require more imports than weak economies. They can also increase their exports to the UK if their economy is growing.
What does the circular flow of income look like?
