Economics Theme 2 Flashcards
1
Q
How is economic growth measured? (short and long run)
A
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
2
Q
What is the difference between nominal and real values?
A
A nominal value is expressed in monetary terms, so doesn’t take into account inflation.
A real value is adjusted for inflation.
3
Q
What is the difference between total and per capita?
A
Total is all the values added up.
Per capita is the total divided by the population to show the average per person.
4
Q
What is the difference between volume and value?
A
Volume looks at the quantity of goods and services produced.
Value looks at the monetary worth of goods and services produced.
5
Q
What is GDP?
A
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)
6
Q
What is GNP?
A
Gross National Product
Value of all goods and services produced by domestic businesses, including abroad.
7
Q
What is GNI?
A
Gross National Income
The total level of formal income in a country, but doesn’t include informal income.
8
Q
What 2 things can the rate of economic growth be compared to?
A
The rate of growth over time
The rate of growth in other countries
9
Q
What is the difference between income and wealth?
A
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.
10
Q
What is Purchasing Power Parity and how is it used?
A
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
11
Q
What are the limitations of using GDP to compare living standards between countries and over time?
A
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)
12
Q
Why does the government research UK national wellbeing? What is the relationship between incomes and happiness?
A
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.
13
Q
Why might happiness not be a useful indicator for governments?
A
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.
14
Q
Inflation, deflation and disinflation definitions
A
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.
15
Q
How is the UK inflation rate calculated using Consumer Prices Index (CPI)?
A
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.
16
Q
What are the limitatons of CPI in measuring the rate of inflation?
A
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.
17
Q
What are the main differences between CPI and RPI?
A
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
18
Q
Why does an increase in aggregate demand lead to demand-pull inflation and a decrease in aggregate supply lead to cost-push inflation?
A
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.
19
Q
What are the effects of inflation on consumers, firms and governments?
A
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
20
Q
What are the 2 measures of unemployment?
A
The claimant count
UK labour force survey
21
Q
What are some of the problems with the Claimant Count?
A
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
22
Q
What are some of the problems with the Labour Force Survey? Why is it better than the Claimant Count?
A
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
23
Q
What is underemployment and what are some examples?
A
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
24
Q
What is the difference between unemployment and underemployment?
A
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.
25
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)
26
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
27
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
28
What are the 4 causes of unemployment?
Structural
Frictional
Seasonal
Cyclical
29
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.
30
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
31
Seasonal unemployment definition and fixes.
Seasonal unemployment occurs 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)
32
Cyclical unemployment definition and fixes. (Also called demand deficiency unemployment)
Cyclical unemployment is unemployment 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
33
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.
34
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.
35
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
36
What are the 3 components of the balance of payments?
The current account
The capital account
The financial account
37
What are the 4 parts of the current account?
Trade in goods
Trade in services
Primary income
Secondary income
38
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.
39
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
40
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
41
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 migrant workers.
42
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.
43
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.
44
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)
45
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
46
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
47
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.
48
What are the components of aggregate demand?
C + I + G + (X-M)
Consumption, Investment, Government spending, Imports and Exports
49
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.
50
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.
51
What are interest rates and how do they influence consumer spending?
Interest rates tell you 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.
52
What is consumer confidence and how does it influence consumer spending?
Consumer confidence is an 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.
53
What are wealth effects and how do they influence consumer spending?
The wealth effect is a behavioral 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.
54
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.
55
How does the rate of economic growth influence investment?
When there is a fast rate of economic growth, capital deteriorates 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.
56
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.
57
What is "animal spirits", and how does it influence investment?
"Animal spirits" is a term created by Keynes to describe how 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.
58
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.
59
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.
60
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.
61
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
62
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.
63
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.
64
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.
65
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.
66
How does protectionsim influence the net trade balance?
When there is more free trade (e.g. EU) there are new import and export opportunities.
If the UK imposes protectionist measures on other countries, imports will fall. Exports may also fall if the UK receives retaliation measures.
67
What are some non-price factors that influence the net trade balance?
Changes in taste and fashion
Productive capacity of the economy
Product differentiation
Design, quality, reliability
After sales services, warranties
These all influence the demand for imports (to the UK from other countries) and exports ( from the UK to other countries)
68
What is the difference between a movement along and a shift in the AS curve?
Movements along the curve are caused by changes in aggregate supply caused by changes in the price level.
Shifts of the curve are caused by changes in aggregate supply caused by changes in a variable other than the price level.
69
Aggregate supply definition
Aggregate supply is the total value of output of the economy at a given price level at a given point in time.
70
What are the 5 main influences on consumer spending?
Disposable income
Savings
interest rates
Consumer confidence
Wealth effects
71
What are the 7 main influences on investment?
Rate of economic growth
Business expectations and confidence
Animal spirits
Demand for exports
Interest rates
Access to credit
Government and regulations
72
What are the 2 main influences on government expenditure?
The trade cycle
Fiscal policy
73
What are the 5 main influences on the net trade balance?
Real incomes
Exchange rates
State of the world economy
Degree of protectionism
Non-price factors
74
What is the difference between Short Run Aggregate Supply and Long Run Aggregate Supply?
In the short run, at least one factor of production is fixed, whilst in the long run all factors of production are variable.
An expansion or contraction in the SRAS curve is caused by a change in the price level.
A shift of the SRAS curve is caused by a change in other factors.
The LRAS curve shows the productive capacity of an economy given the available factors of production.
The LRAS curve will shift outwards if there is an improvement in the quality or quantity of the factors of production
A movement along the LRAS curve is caused by a change in AD.
75
What are the 3 main factors that influence short run aggregate supply?
Changes in costs of raw materials and energy
Changes in exchange rates
Changes in tax rates
76
How do changes in costs of raw materials and energy, changes in exchange rates and changes in tax rates influence short run aggregate supply?
A decrease in costs of production will shift SRAS right and an increase will shift SRAS left.
Most firms in the economy use raw materials or energy so will see an increase or decrease in production costs if the costs of these increase.
Many firms import raw materials and energy, so will see an increase in production costs if there is an appreciation or depreciation in the exchange rates.
Taxes also increase production costs for firms. Even though some firms will be able to pass this onto the consumer instead, as a whole aggregate supply in the economy will shift left.
77
Explain why the Keynsian LRAS curve is the shape it is.
The classical LRAS curve is a straight vertical line because the economy is maximising use of its resources at any point in time.
Keynes believed that an economy can settle at a level of output below full employment. An increase in aggregate demand can increase economic growth, as well as an increase in LRAS, wheras the classical view is that only an increase LRAS can increase economic growth.
78
What are the 6 main factors influencing long run aggregate supply?
Technological advances
Changes in relative productivity
Changes in education and skills
Changes in government regulation
Changes in demographics and migration
Competition policy
79
How can technological advancements, changes in productivity and changes in education and skills influence LRAS?
LRAS shifts right when there is a change in the quantity and/or quality of the factors of production.
Technological advacements make production processes more efficient, which decreases average costs. It may also increase the quality of goods depending on where the advancements are.
An increase in productivity means each worker is producing more during their shfit. This will increase the maximum number of units possible to produce.
Education and skills will increase the quality of labour, which is one of the factors of production. It will also lead to more innovation in future.
80
How can changes in government regulation and competition policy influence LRAS?
Governments often have regulatory frameworks to increase the level of competition in markets, as competition forces firms to lower their costs and be more efficient. It also improves quality and choice for consumers. The Competition and Markets Authority (CMA) was set up in 2013 to enhance competition in the UK.
81
How can changes in demographics and migration influence LRAS?
Ageing population - people live longer but don't work, so slower growth in labour force
Migrants - usually of working age so increase size of labour force
High-skill migrants - innovation and new production processes
82
What are injections and withdrawels in the circular flow of income?
Injections: Spending in the economy from sources other than households that adds to the circular flow. Government spending + Investment + Exports
Withdrawels: Expenditure in the economy that does not flow back to firms and leaves the circular flow. Savings + Taxes + Imports
83
What is the impact of injections into the economy being greater than withdrawels from the economy and vice versa?
If Injections > Withdrawels: Expendature will be more than incomes, firms will receive more revenue, output will rise until a new equilibrium is reached, more economic activity.
If Withdrawels > Injections: Expendature will be less than incomes, firms will receive less revenue, output will fall until a new equilibrium is reached, less economic activity.
84
How are equilibrium Price Level and Real GDP determined?
The macroeconomic equilibrium price is the point at which aggregate demand equals aggregate supply.
This is also referred to as equilibrium real national output in the specification.
A curve may shift left or right, which would change the market equilibrium.
85
Multiplier effect definition
The process by which an injection into the economy leads to an even greater change in national output than the value of the initial injection.
86
What are the two multiplier formulae?
K = 1/MPW
K = 1/(1-MPC)
87
Explain the multiplier process.
An injection into the circular flow of income will result in an immediate increase in AD. The increase in output will increase profit for firms, and workers will gain some of the profit through higher wages. Some of this increased income will be spent in the economy, whilst the rest will be withdrawn. The money that is not withdrawn will be spent again, leading to a further increase in AD, and this is the multiplier effect of the initial injection. There can also be a negative multiplier effect if the government cuts spending.
88
What are the 5 marginal propensities?
MPC (consume)
MPS (save)
MPT (tax)
MPM (import)
MPW (withdraw)
89
What is the multiplier ratio?
This is the ratio of a change in real income to the initial injection that brought it about. For example, if a £2M injection in to the circular flow caused a £4M increase in national income, the value of the multiplier would be 2.
90
What is the significance of the multiplier for shifts in AD?
The greater the marginal propensity to consume, the greater the multiplier effect and therefore the greater the increase in AD.
91
What is the formula for MPW?
MPW = MPS + MPT + MPM
92
What is the Marginal Propensity to Consumer (MPC)?
The proportion of disposable income that is spent in the economy. For example, if the marginal propensity to consume was 0.6, 60% of disposable income is spent.
93
What is the Marginal Propensity to Save (MPS)?
The proportion of disposable income that is saved.
94
What is the Marginal Propensity to Tax (MPT)?
The proportion of disposable income that goes to the government in the form of taxation.
95
What is the Marginal Propensity to Import (MPM)?
The proportion of disposable income that is spent on imports.
96
What is the relationship between consumption and savings (and savings ratio)?
Generally, as consumers save more, they spend less, and vice versa.
The savings ratio gives an idea of the average extent of saving for all households in the economy.
It is calculated as the percentage of disposable income that is saved.
E.g. If disposable income is £347 and they save £35, savings ratio = 35/347 x 100
97
What variables influence the multiplier ratio?
Spare capacity in the economy (If at full capacity, an increase in AD won't be met with an increase in AS)
Propensity to spend on domestic goods and services compared to imports
Rate of tax on disposable income
Consumer and business confidence in the economy
98
What factors can cause economic growth? Short run and long run
Increase in components of AD
Consumption
Investment
Government spending
Exports
Fewer imports
Tax cuts (increased consumption)
Higher wages (increased consumption and productivity)
Low interest rates (increased investment)
Long run:
Increase in quantity of factors of production
Increase in quantity of factors of production
Technological advancements
Increase in productivity
-Increase in labour force
Discovery of raw materials
99
What are the benefits of economic growth?
Higher living standards (higher wages)
Higher employment
Reduced budget deficit (higher tax revenue)
Higher investment (higher confidence, higher profits)
100
What are the disadvantages of economic growth?
Higher inflation (demand-pull if increase in AD, cost-push if wage pressures)
Current account deficit increase (more imports)
Environmental costs (more pollution)
Higher inequality (most economic agents benefit, but those with businesses and assets benefit much more)
101
What is export-led economic growth?
When a country exports in areas where it has a comparitive advantage, has higher quality exports and exports in a greater quantity, which leads to economic growth as the value of exports is greater than the value of imports, resulting in (x-m) being a positive addition to AD.
102
What does the trend line of the Trade Cycle show?
The trend line shows the average level of GDP growth over time.
103
Output gap definition
An output gap is the difference between the actual output of an economy and its potential output.
Negative output gap when actual < potential
Positive output gap when actual > potential
104
Why is it difficult to measure an output gap?
Difficult to measure actual AD and AS
Based on estimates
Capital is constantly depreciating, so maximum potential AS is constantly changing
105
What are the impacts of a negative output gap?
Unemployment
Recession (sometimes output gap = recessionary gap)
106
What are the impacts of a positive output gap?
High inflation (also called inflationary gap)
Low unemployment (possibly even over-employment [workers working more than they'd like to])
107
What are the 4 stages of the Trade Cycle?
Boom
Slump
Recession
Recovery
108
What are the characteristics of a boom period?
Period of high economic growth
Inflationary pressure
Low unemployment
High capital investment
109
What are the characteristics of a recession?
Falling rate of Real GDP
Low inflation, sometimes deflation (unless stagflation when recession and inflation at the same time)
High unemployment (unless stagflation)
Low levels of capital investment
110
How does high economic growth benefit consumers?
Improvements in living standards
Increased income --> Increased disposable inome --> Low-income earners can spend more on necessities and high-income earners can spend more on luxuries
Some workers will work more as incomes are higher, some workers will work less as they can now afford to. More choice of hours working.
111
How does high economic growth benefit firms?
Increased demand --> Increas in revenue --> Increase in profit
Owners and shareholders of firms see an increase in income (e.g. higher bonuses and dividends)
Higher amounts of retained profit to reinvest in the business
112
How does high economic growth benefit the government?
More people employed --> Higher tax revenue --> Finance budget deficit and increase government spending
113
How does high economic growth negatively impact consumers and firms?
Greater income inequality (low-income / minimum wage workers see little to no wage rise)
Greater opportunity cost of spending income on consumer goods rather than capital goods.
Inflationary pressure (AD higher than AS, firms increase prices, wage-price spirals)
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How does high economic growth negatively impact the government and environment?
Increased pollution, congestion, expoloitation of non-renewable resources
Higher incomes --> More imports --> Current account deficit --> Financed through borrowing
115
What are the 7 macroeconomic objectives?
Economic Growth
Low Unemployment
Low and Stable Rate of Inflation
Balance of Payments Equilibrium on Current Account
Balanced Government Budget
Protection of the Environment
Greater Income Equality
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Monetary policy definition
Monetary policy is action that a country's central bank or government can take to influence the money supply and the cost of borrowing money.
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Fiscal policy definition
Fiscal policy is the use of government spending and taxation to influence the level of economic activity in the economy.
118
What are the 2 monetary policy instruments?
Interest Rates
Quantitative Easing (asset purchases to increase money supply)
119
What are the 2 fiscal policy instruments?
Government Spending
Taxation
120
What is the difference between the bank rate and interest rate?
The base rate is the minimum interest rate set by the Monetary Policy Committee of the Bank of England.
Interest rates.
The interest rate is the amount an economic agent is charged for borrowing money, shown as a percentage of the loan, and the amount an economic agent is paid for saving money, shown as a percentave of the savings.
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Quantitative Easing definition
Quantitative easing is a monetary policy action whereby a central bank purchases predetermined amounts of government bonds or other financial assets, in order to stimulate economic activity.
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Government Spending definition
Government spending is spending by the public sector on goods and services such as education, health care and defence.
123
Taxation definition
Taxation is the imposition of compulsory levies on individuals or firms by governments to raise revenue for government expenditure.
124
What are the aims of contractionary and expansionary monetary policy?
Contractionary monetary policy: Makes saving more attractive and borrowing less attractive --> Decrease economic activity --> Decrease inflation rate. Used during high inflation.
Expansionary monetary policy: Makes saving less attractive and borrowing more attractive --> Increase in economic activity --> Increase economic growth. Used during recession.
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How does quantitative easing stimulate economic activity? Why might it be used instead of lowering base rate?
Used when base rate can't be lowered any further (e.g. 0.1%)
BoE buys government bonds with electronic cash that did not previously exist --> Increases size of bank reserves --> Commercial banks end up with more cash --> Lend out more money to individuals and firms, and may lower interest rate --> Stimulates economic activity --> Economic growth --> Shorter and shallower recession.
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What are the aims of contractionary and expansionary fiscal policy?
Contractionary: Rasing taxes or cutting government spending --> Economic agents have less profit and disposable income --> Decreases AD --> Decreases price level --> Lowers inflation. Used during high inflation.
Expansionary: Reducing taxes or increasing government spending --> Economic agents have more profit and disposable income --> Increases AD and multiplier effect --> Increases real GDP --> Higher economic growth. Used during recession.
127
Why are there time lags once fiscal policy changes are announced?
The changes aren't implemented until the next tax year.
128
What is the difference between government/budget/fiscal deficit and surplus?
Deficit when government spending is higher than tax revenue.
Surplus when government spending is lower than tax revenue.
129
What is a criticism of quantitative easing?
Majority of money created went into financial markets like the stock market, which is mostly owned by the wealthiest minority, so most families saw no benefit.
130
What is the difference between direct and indirect taxation?
A direct tax is one that the taxpayer pays directly to the government. These taxes cannot be passed on to any other person or group.
An indirect tax is one that can be passed on to another individual or business by the individual or business that owes it.
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What are 4 examples of direct taxes?
Income tax
Corporation tax
National insurance
Inheritance tax
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What are 4 examples of indirect taxes?
Value added tax (VAT) - ad valorem
Customs duties on imports - ad valorem
Excise duties (e.g. sugar tax, alcohol, tobacco) - specific
Landfill tax - specific
133
What is the role of the Bank of England Monetary Policy Committee?
Made up of 9 members, including the governor of the BoE, Andrew Bailey.
Meet 8 times a year to look at how the economy is working and what action is required by them.
They are responsible for setting the UK base rate.
134
What demand side policies were used during The Great Depression and The Global Financial Crisis?
The Great Depression: Less consumer spending --> Monetary and fiscal policy tightened in the US & UK (contractionary policies) --> Demand fell even further --> Longer and deeper recession.
The Global Financial Crisis: Less consumer spending --> Monetary and fiscal policy loosened in the US & UK (expansionary policies, including quantitative easing) --> Demand increased --> Shorter and shallower recession.
135
What factors limit the effectiveness of monetary policy?
Size of change in base rate
Size of the multiplier
Point in the trade cycle
Conflicts with other objectives
Changing the base rate is less effective at controlling cost-push inflation, especially if its caused by external forces (e.g. war gas prices).
136
What factors limit the effectiveness of fiscal policy?
Size of the change in government spending or tax
Time lags between changes proposed and implemented
Size of the multiplier
Amount of spare capacity in the economy / How close to full employment
137
What is the difference between free-market and interventionist methods?
Free market - reducing regulation so that markets can work more efficiently.
Interventionist - government intervention in markets to overcome market failure and improve the economic environment.
138
What are some free-market and interventionist policies that can be used to increase incentives?
Market-based:
Reduction in income tax --> Encourages people to enter workforce because they can keep more of their income
Reduction in corporation tax --> Allows firms to keep more of their profits, encouraging them to invest more
Interventionist:
Investment grants --> Encourages investment in capital
Regional policy (e.g. enterprise zones) --> Encourages firms to set up in depressed regions
139
What are some free-market and interventionist policies that can be used to increase competition?
Free-market:
Deregulation - removes barriers to entry and opens market to freer competition
Privatisation - minimal state control increases efficiency
Interventionist: Competition policy - Prevents growth of monopoly power and abuse of monopoly power, removes barriers to entry
140
What are some free-market and interventionist policies that can be used to reform the labour market?
Free-market:
Reduce or abolish national living wage --> market forces allocate wages --> labour market clears
Reduce trade union power --> fewer employment restrictions --> labour market more efficient
Interventionist:
Immobility of labour policies
Improving information on job vacancies, subsidising worker relocation --> reduces labour shortages and surpluses --> improves labour market flexibility
141
What are some free-market and interventionist policies that can be used to improve skills and quality of the workforce?
Free-market: Remove restrictions on free movement of labour
Interventionst: Investment in training schemes --> higher-skilled workforce
Investment in healthcare --> more productive and healthy workforce
142
What are some free-market and interventionist policies that can be used to improve infrastructure?
Free market: Privatisation (more efficient
Interventionist: Investment in roads and railway
Investment in utilities (gas, water, electricity)
143
What is the main strength of supply side policies?
Reduce inflation (shifts AS right)
144
What are the weaknesses of supply-side policies?
Time lags
Significant government expenditure often - budget deficit
Sometimes negative impacts on equity and distribution of wealth (e.g. abolishing minimum wage)
Environmental impacts (e.g. deregulation)
145
What are 6 potential conflicts and trade-offs between the macroeconomic objectives?
Economic growth & Protection of the environment (Kuznets Curve)
Economic growth & Balanced budget deficit (expansionary fiscal policy to create economic growth)
Economic growth & BoP equilibrium (higher incomes = more imports)
Economic growth & Greater income equality (benefits of economic growth go to producers of economic growth)
Low unemployment & Low inflation (Phillips Curve)
Low unemployment & BoP equilibrium (more people with income = more imports)
146
Explain the Phillips Curve.
The Short-Run Phillips Curve indicates that when an economy experiences low levels of unemployment, inflation is likely to be high.
This usually happens in the boom phase of the trade cycle when the economy is operating near full capacity.
It also indicates that when unemployment is high, inflation is likely to be low.
This would occur when the economy is in a recession where the price level is low due to a lack of AD.
However, this relationship does not hold when there is stagflation (high inflation and limited economic growth), like the UK in the 1970s.
When that happens, we shift the SRPC outwards indicating higher unemployment and inflation, which is synonymous to a fall in AS.
In the 1990s many economies had low inflation and low unemployment due to low-priced imports from emerging countries.
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What are the potential policy conflicts of the following?
High unemployment --> Expansionary fiscal policy
Low economic growth --> Loosening monetary policy
High inflation --> Tightening monetary policy
Budget deficit --> Contractionary fiscal policy
Trade deficit --> Tightening monetary policy
Low economic growth --> Supply side policy
Increased budget deficit, Incrased environmental harm
Increased inflation, Increased trade deficit
Decreased economic growth, Increased unemployment
Decreased economic growth, Increased unemployment
Decreased economic growth, Increased unemployment
Increased inequality, Increased environmental harm
148
What are 4 examples of public goods?
Street lighting
Law enforcement
Flood defence
Civil defence siren
149
Competition policy definition
Competition policy is a type of government policy aimed at reducing monopoly power in order to increase efficiency and to ensure fairness for consumers.
150
Why is economic growth a macroeconomic objective?
The government aim to achieve strong, sustained and stable levels of economic growth to try and reduce the effects of the trade cycle, such as the large fluctuations of economic growth. A sustainable long term economic growth rate is around 3 or 4 percent.
151
Why is low unemployment a macroeconomic objective? Why not aim for 0% unemployment?
The government aim to have an unemployment rate of around 5%, which is close to the full employment rate. This allows for some frictional unemployment within the economy, allowing workers the time to find jobs which they’re suited to and therefore are likely to stay in for a long time.
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Why is low and stable rate of inflation a macroeconomic objective?
A stable inflation rate is around 2 to 3 percent. This encourages consumers to spend their money sooner and offers price stability to consumers, firms and foreign investors. Price stability encourages foreign investors and firms to invest. This is due to the fact that they’re able to make long term decisions knowing that the probability of these decisions won’t change as a result of large decreases or increases in the inflation rate.
153
Why is balance of payments equilibrium on the current account a macroeconomic objective?
If there is a current account deficit, demand for foreign currencies is higher than demand for domestic currency, which can cause the exchange rate to depreciate, adversely affecting living standards. The government will likely finance the deficit by borrowing, which increases national debt, and therefore the interest the government will have to pay on debt in the future.
154
Why is balanced government budget a macroeconomic objective?
A budget deficit will increase government debt. This increases the opportunity cost of debt interest payments. A higher deficit will also lead to a higher percent of national income being spent on debt interest payments.
155
Why is protection of the environment a macroeconomic objective?
This is needed in order to prevent the depletion of scarce resources such as oil. Without the protection of the environment, future generations may not have access to these resources and therefore future living standards may fall by a large amount. In addition to this, governments may aim to reduce pollutions and the emission of fossil fuels in order to prevent the negative externalities associated with this, such as the health problems it causes for people with asthma or the damage it does to wildlife.
156
Why is greater income equality a macroeconomic objective?
Governments will try to avoid high levels of inequality which are associated with unrest amongst citizens as well as other social tensions. Although this is the case, some income inequality is still desirable due to the fact that without income inequality there would be no incentive for citizens to work hard or innovate. Governments aim to have a Gini coefficient of around 0.3-0.4 where 0 represents everyone having the same income and 1 represents a single individual receiving all of the income.
157
For what 3 reasons is the aggregate demand curve downwards sloping?
The
real balance effect; for example, an increase in the average price level reduces
the purchasing power and therefore real output demanded.
At higher average
prices, an economy is less likely to export, more likely to import, therefore
decreasing AD.
At higher average prices, the interest rate is likely to be higher, meaning that investment is lower and savings are higher.
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Why is the AS curve upwards sloping?
If real output is to increase in the short run, firms will have to pay overtime or
more money for the quick delivery of raw materials, etc.
As such, as real output
rises, costs per unit to the firms and industries are likely to rise.
These
increased costs will tend to be passed on to the consumer through higher
prices, so as real output increases, so does the price level.
159
What does the circular flow of income look like?
160
What are the main causes of inflation?
Demand-pull:
Lower interest rates
Increase in AD when the economy at full capacity (Keynes diagram)
Cost-push:
Depreciation of exchange rate (imports more expensive
High aggregate prices (e.g. oil)
Rising wages (wage-price spiral)
161
What are the main factors influencing productivity in an economy?
Skills and qualifications of workers (relevant training for the job)
Nature of employment (temporary/part-time jobs workers are less productive than permanent/full-time workers)
Worker moral (performance of economy and industry, employment laws, trade unions)
Technological progress (new technology more productive than old)
Price of labour (if cheap, less incentive for firms to switch to capital-intensive production, which is normally more productive than labour)
Rules and regulations (easy or difficult to make unproductive redundant, job security)
Power of trade unions (unproductive if industrial action)
Level of investment (in the long run, investment in r&d, technology and working conditions increases productivity)
162
What are main causes of the UKs low productivity?
Low real wages (cheaper for firms to use labour-intensive production methods rather than invest in machinery and new technology)
Flexible labour markets (more part-time and temporary contracts - cheap for firms to employee workers instead of investing in machinery and new technology which would be more productive)
Brexit & Covid uncertainty (low confidence, unwilling to invest in machinary and new technology)
Labour hoarding (firms unwilling to make workers redundant during poor economic performance because they will eventually need to rehire, which involves redundancy, re-hiring and training costs)
After global financial crisis: Credit crunch (more difficult to access finance for investment in machinery and new technology)
Productivity puzzle - not completely understood
163
What are the benefits of economic growth / LRAS / PPF / GDP?
Higher average incomes
Higher living standards
Lower unemployment
More employment opportunities
Lower government borrowing
Budget surplus
Improved public services
Lower opportunitiy cost of government spending
Higher business and consumper confidence
Economic development
Decline in absolute poverty
164
What are 3 evaluation points of economic growth / LRAS / PPF / GDP?
Marginal benefit of economic growth much higher in developing countries, developed countries already have high living standards and low absolute poverty.
More pollution and congestion - may lower living standards overall. Damages environment.
Distribution of economic growth - high income or low income benefiting? May increase share prices and other assets, but do little to lift lowest income people out of absolute poverty.
