Edexcel A Economics - Theme 2 Flashcards
What is economic growth?
Economic growth is a sustained rise in the value of the GDP, an increase in national output.
What is real GDP?
Real GDP is the value of GDP adjusted for inflation.
What is nominal GDP?
Nominal GDP is the value of GDP without being adjusted for inflation.
What is total GDP?
The combined monetary value of all goods and services produced within
a country’s borders during a specific time period
What is GDP per captia?
The value of total GDP divided by the population of the country.
What is gross national product? (GNP)
The market value of all products produced in
an year by one country.
It includes income earned overseas minus incomes earned by overseas residents.
What is gross national income? (GNI)
The total value of all income in a country, plus product taxes (subtract subsidies), plus receipts of primary income from abroad.
What is PPP?
Purchasing Power Parity
How much the exchange rate needs adjusting so that an exchange between countries is equivalent.
How is PPP calculated?
A basket of the same goods is collected in each country and the costs of the basket of goods are compared.
What are the limitations of using GDP to compare living standards over time?
GDP gives no indication of distribution of income.
GDP may need to be adjusted in terms of purchasing power, so that international price differences can be calculated.
There are large hidden economies, black markets.
GDP gives no indication of welfare.
What is the national happiness index?
It is calculated in the UK by the ONS
The UK economy grew by 5% in GDP per capita between 2007 and 2014, but showed no change in life satisfaction.
However, generally, the higher the GDP per capita, the higher the average life
satisfaction score.
What is inflation?
Inflation is the sustained rise in general price level over time.
What is deflation?
Deflation is the sustained fall in general price level over time.
What is disinflation?
Disinflation is the falling rate of inflation. When price levels are still rising but at a slower rate.
How is inflation calculated using CPI?
Consumer Price Index (CPI)
This measures purchasing power with the Family Expenditure Survey.
The survey finds out what consumers spend their income on. A basket of goods is created.
The goods are weighted according to how much income is spent on each item.
What are the limitations to CPI?
The basket of goods is only representative to the average household. Not accurate to people who don’t own cars as 14% of their income is not spent on motoring.
Different demographics have different spending patterns.
CPI is slow to respond to new goods and services.
Hard to make historical comparisons due to technology.
What is RPI?
Retail price index
This is an alternative measure of inflation.
RPI includes housing cots, such as payments on mortgage interest and council tax.
What is CPIH?
This is CPI including a measure of owner occupiers’ housing costs (OOH), a measure of inflation.
What is demand pull inflation?
When aggregate
demand is growing unsustainably, there is pressure on resources. Producers increase their prices and earn more profits. It usually occurs when resources
are fully employed.
What are the main triggers of demand pull inflation?
Depreciation of the exchange rate.
Fiscal stimulus, lower taxes
Lower intrest rates
High growth in the UK
What is cost push inflation?
Occurs when
firms face rising costs
When does cost push inflation occur?
Raw material become more expensive.
Labour becomes more expensive.
Expectations of inflation.
Indirect taxes.
Depreciation in the exchange rate causes imports to become more expensive.
Monopolies
How does growth of the money supply cause inflation.
The Bank of England printed more money, there would be more money flowing in the economy. It is only inflationary if the
money supply increases at a faster rate than real output
What is hyperinflation?
Hyperinflation is when the prices of goods and services rise more than 50 percent a month.
What is quantitative easing and how does it simulate the economy?
If interest rates are already very low, it is not
possible to lower them much more.
Central bank creates money electronically.
The money is used by the central bank to buy (financial assets) government bonds from financial institutions.
Price of government bonds increases and yield decreases.
Financial institution either loan this money out or invest in riskier corporate bonds.
The price of corporate bonds increase and yield decrease, reducing the cost of borrowing money.
Access to credit improves and willingness to lend increases
This stimulates borrowing, spending and investment (AD)
What is the effect of inflation on consumers?
Low and fixed income consumers are affected the most, due to regressive effect.
Purchasing power decreases.
If consumes have loans, the value of repayment would be lower
What is the effect of inflation on firms?
Lower interest rates lead to create borrowing and investment.
Workers might demand high wages, which could increase the costs of production if interest rates are high.
Less international competitive is inflation is high.
Unpredictable inflation lowers business confidence.
What is the effect of inflation on the government?
The government will have to increase the value of the state pension and welfare payments, because the cost of living is increasing.
What is the effect of inflation on the workers?
Real incomes fall with inflation.
If firms face higher costs, there could be more redundancies when
firms try and cut their costs.
What is unemployment?
The unemployed are those able and willing to work, but are not employed. They are actively seeking work and usually looking to start within the next two weeks.
What are the two measures of unemployment in the UK?
The Claimant Count
The International Labour Organisation (ILO) and UK Labour Force Survey (LFS)
What is the Claimant Count
This counts the number of people claiming unemployment related benefits (JSA) and are actively looking for work.
Evaluate the Claimant Count
Not every unemployed person is eligible for, or bothers claiming JSA.
Those with partners on high incomes.
Normally an underestimate.
What is the ILO and LDS?
The International Labour Organisation (ILO) and the UK Labour Force Survey (LFS)
It directly asks people if they meet the following
criteria:
1. Been out of work for 4 weeks
2. Able and willing to start working within 2 weeks
3. Workers should be available for 1 hour per week.
What is underemployed?
The underemployed are those who have a job, but their labour is not used to its full productive potential.
What is the effect of unemployment on consumers?
Less disposable income and their standard of living may fall as a result.
Psychological consequences of losing a job,
What is the effect of unemployment on firms?
Firms have a larger supply of labour to employ from. This causes wages to fall, which would help
firms reduce their costs.
Consumers have
less disposable income, consumer spending falls so firms may lose
profits.
Producers which sell inferior goods might see a rise in sales.
What is the effect of unemployment on workers?
There is a waste of workers’ resources. They
could also lose their existing skills if they are not fully utilised.
What is the effect of unemployment on the government?
Government may have to
spend more on JSA (opportunity cost)
Receive less revenue from income tax
What is the effect of unemployment on society?
An opportunity cost to society, since workers could have
produced goods and services if they were employed.
Increased crime and vandalism.
What is inactivity of workers?
Those who are unemployed but not actively looking
for jobs.
If the number of the economically inactive increases, the
size of the labour force may decrease, which means the productive potential
of the economy could fall.
What are the 4 causes on unemployment?
Structural
Frictional
Seasonal
Cyclical
What is structural unemployment?
Long term decline in demand for the goods and services in the industry.
Labour is replaced by capital.
Worsened by geographical and occupational immobility of labour.
Globalisation also contributes to structural unemployment. Labour is outsourced to cheaper countries with lower labour costs.
What is frictional unemployment?
The time between leaving a job and looking for another job
What is seasonal unemployment?
Occurs during certain point in the year. Tourist industry.
What is cyclical unemployment?
Caused by a lack of demand for goods and services, and it usually occurs during periods of economic decline or recessions.
What is real wage inflexibility?
Wages above the market equilibrium may cause unemployment.
However, cutting wages during times of weak consumer spending would cause further falls in consumer spending, and there would be even lower economic
growth,
What are the affects of migration on employment and unemployment?
Migrants are usually of working age, so the supply of labour at all wage rates tends
to increase with more migration.
Increase job competition.
Bring high quality skills.
What is the balance of payments?
A record of all financial transactions made between consumers, firms and the
government from one country with other countries.
What is an export?
Exports are goods and services sold to foreign countries, and are positive in the balance of payments. This is because they are an inflow of money.
What is an import?
Imports are goods and services bought from foreign countries, and they are negative on the balance of payments. They are an outflow of money.
What is the balance of payment made up of?
The current account
The capital account
The financial account
What is the current account?
The current account on the balance of payments is the balance of trade in goods
and services. It includes:
- Trade in goods
- Trade in Services
- Income
- Transfers
What is the current account?
The current account if the value of financial flows within an economy. It includes:
- Trade in goods
- Trade in Services
- Income
- Transfer payments
What are the UKs main macroeconomic objectives?
Full employment
Low, stable inflation
A sustainable current account on the balance of payments
Sustainable economic growth
What is the interconnectedness of economies though international trade?
The sum of all countries’ trade balances should be zero, since what one
country exports will be imported by another country.
International trade has meant countries have become interdependent.
What is AD?
Aggregate demand is the total demand in the economy.
It measures spending on goods and services by consumers, firms, the government and overseas consumers
and firms.
What is the equation for AD?
AD = C + I + G + (X - M)
Draw the AD curve
Changes in the price level cause movements along the demand curve.
Why is the AD curve downward sloping?
Higher prices lead to a fall in the value of real incomes.
If there was high inflation in the UK so that the average price level was high,
foreign goods would seem relatively cheaper. Therefore, there would be
more imports, so the deficit on the current account might increase, and AD
would fall.
High inflation generally means the interest rates will be higher.
What are the reasons for a shift right in AD?
Consumers and firms have higher confidence levels, so they invest and spend
more, because they feel as though they will get a higher return on them.
Monetary Policy Committee lowers interest rates
Lower taxes
An increase in government spending will boost AD.
Depreciation in a currency means M is more expensive, and X is cheaper, so
AD increases.
Wealth effect.
Greater availability of credit
What is consumer spending?
How much consumers spend on goods and services. This is the
largest component of AD
What is disposable income?
Disposable income is the amount of income consumers have left over after taxes and social
security charges have been removed.
What is MPC?
MPC = Marginal propensity to consume
A consumer’s marginal propensity to consume is the proportion of each
additional pound of household income that used for consumption of goods and services.
What is MPS?
MPS = Marginal propensity to save
A consumer’s marginal propensity to save is the proportion of each
additional pound of household income that is used for saving.
What are the influences on consumer spending
Interest rates
Consumer confidence
Wealth effects.
What is the wealth effect.
A rise in the price of houses makes people feel wealthier, so they are likely to spend more. This
is the wealth effect.
What is gross investment?
This is the amount that a firm invests in business assets that does not
account for depreciation’s.
What is a investment depreciation?
A depreciation is when something starts to lose value.
What is net investment?
The actual addition to the capital stock of an economy, after depreciation’s have been considered.
Net investment= gross investment – depreciation.
How does rate of economic growth affect investment?
If growth is high, firms will be making more revenue due to higher rates of
consumer spending.
How does rate of business expectations and confidence affect investment?
If firms expect a high rate of return, they will invest more. If they are uncertain about the future they my postpone investments.
Keynes coined the term animal spirits when describing instincts and
emotions of human behaviour, which drives the level of confidence in an
economy.
How does the demand for exports affect investment?
The higher demand is, the more likely it is that firms will invest.
How does interest rates affect investment?
Investment increases as interest rates falls.
How does access to credit affect investment?
If banks and lenders are unwilling to lend firms will find it harder to gain
access to credit.
How does the influence of government and regulations investment?
The rate of corporation tax could affect investment. Lower taxes means firms
keep more profits, which could encourage investment.
What is the trade cycle?
Also known as the business cycle.
Refers to the stage of economic growth the economy is in.
Boom, recession, slump, recovery
What is fiscal policy?
Governments use fiscal policy to influence the economy. It involves changing government spending and taxation.
It is a demand side policy
What are examples of fiscal policy the demand side fiscal policy the government might use?
Discretionary fiscal policy
Automatic stabilisers
Expansionary fiscal policy
Contractionary fiscal policy
What is discretionary fiscal policy?
A policy which is implemented through one-off policy changes
What are automatic stabilisers?
Policies which offset fluctuations in the economy.
These include transfer payments and taxes. They are triggered without
government intervention.
What is expansionary fiscal policy?
During periods of
economic decline. This involves increasing spending on transfer payments or
on boosting AD, or by reducing taxes.
What is contractionary fiscal policy?
Decreasing expenditure on purchases and transfer payments.
How does real income affect the net trade balance?
During periods of economic growth, when consumers have higher incomes
and they can afford to consume more, there is a larger deficit on the current
account.
What is the affect of exchange rates on the net trade balance?
A depreciation of the pound means imports are more expensive, and exports
are cheaper, so the current account trade deficit narrows.
However, it depends on which currency the pound depreciates against.
If demand is price inelastic, exports will not increase
significantly, and the value of exports will decrease.
What is the affect of the state of the world economy on the net trade balance?
A decline in economic growth in one of the UK’s export markets means there
will be a fall in exports. This is because consumer spending in those
economies will fall, due to falling real incomes.
What is the affect does the degree of protectionism have on the net trade balance?
Protectionism is the act of guarding a country’s industries from foreign
competition. It can take the form of tariffs, quotas, regulation or embargoes.
Reduce the trade deficit but may lead to retaliation, exports might decrease
too, which undoes the effect of reduced imports.
What is the affect non price factors on the net trade balance?
A country can become more competitive by being innovative, having higher
quality goods and services, operating in a niche market, having lower labour
costs, being more productive or by having better infrastructure. These
increase exports
What is AS?
Aggregate supply shows the quantity of real GDP which is supplied at difference price levels in the economy
Why is AS upward sloping?
The AS curve is upward sloping because at a higher price level, producers are
willing to supply more because they can earn more profits.
Drawn an AS curve and what causes a expansion or contraction along the AS curve?
If AD increases, there is an expansion in the SRAS.
If AD falls there is a contraction in SRAS.
Draw a shift left and right in SRAS and what are the reasons for a shift.
Cost of employment
Cost of other inputs (raw materials
Government regulation
Exchange rate
What is considered SRAS and LRAS and draw a classical SRAS and LRAS curve.
SRAS: Cost of production and productivity of the factors of input are kept constant. Wages are constant.
LRAS: This is when prices, and the costs and productivity
of factor inputs, can change.
What cause shifts to SRAS?
Cost of production: Cost of employment Cost of inputs Government regulation or intervention Net outward migration Fall in business capital spending
Draw a Keynesian LRAS graph and what assumptions are made?
The Keynesian view suggests that the price level in the economy is fixed until resources are fully employed.
Draw a Classical LRAS graph and what assumptions are made?
This view suggests that output is fixed at each level. All factors of production in the economy are fully employed in the long run.
What factors cause a shift in LRAS?
Things that affect the quantity or quality of the factors of production
Technology advances Changes in relative productivity Changes in education and skills Changes in government regulations Demographic changes and mitration Competition policy
What is the circular flow of income?
This spending and income circulates around the economy in the circular flow of income.
What is a withdrawal from the circular flow of income?
When income is removed from the circular flow.
- Taxes
- Savings
- Imports
What is a withdrawal from the circular flow of income?
A withdrawal from the circular flow of income is money which leaves the economy.
- Taxes
- Savings
- Imports
What is a injection from the circular flow of income?
An injection into the circular flow of income is money which enters the economy.
- Government spending
- Investment
- Exports
What is the distinction between income and wealth?
Income is a flow of money that goes to the factors of production. For example,
wages, welfare payments, profits, dividends, rents and interest are forms of income.
Wealth is a stock of assets, such as savings, shares, property, bonds and pension
schemes.
What does net withdrawals or net injections lead to?
If there are net injections into the economy, there will be an expansion of national
output.
If there are net withdrawals from the economy, there will be a contraction of
production, so output decreases.
Draw the equilibrium point of the AD/AS curve and what needs to happen to reach this point?
The economy reaches a state of equilibrium when the rate of withdrawals = the rate of injections. This is equivalent to the point where AD = AS.
Draw a shift right in AS and when does this occur?
If the economy becomes more productive, or if there is an increase in efficiency,
supply will shift to the right.
Draw a left shift in AD and when does this occur?
If firms have less confidence or there is a recession, AD might shift inwards.
What is the multiplier ratio?
This is the ratio of the rise national income to the initial rise in AD.
It is the number of times a rise in national income is larger than the rise in the initial injection of AD, which led to the rise in national income.
When does the multiplier effect occur and what does it lead to?
When there is new demand in the economy, a net injection into the economy.
This leads to more jobs being created, higher average incomes,
more spending, and eventually, more income is created.
What is MPT?
This is defined as the proportion of each pound taxed by the government.
The higher the rate of tax, the less disposable income each consumer has,
and the smaller the size of the multiplier.
What is MPM
If consumers spend income on imports rather than domestic goods and
services, income is withdrawn from the circular flow of income. This reduces
the size of the multiplier.
What is the equation for the multiplier?
1/(1-MPC)
An open economy has three areas of withdrawals: taxes, imports and savings.
o The marginal propensity to withdraw is calculated by MPW = MPS + MPT +
MPM
The multiplier can also be 1/MPW.
What is the effect of elasticity of supply on the multiper?
If SRAS is elastic it means the size of the multiplier will
be larger.
If SRAS is inelastic, the multiplier effect is likely to be smaller than its potential.
What is a reverse multiplier?
This means that a withdrawal of
income form the circular flow of income could lead to an even larger decrease in income for the economy.
What is economic growth?
Draw this on all possible graphs.
The expansion of the productive potential of the
economy.
How is short run growth calculated?
Calculated annually by the percentage change in real national output.
What are the factors that cause growth?
An increase in AD
Improving the labour force (better quality and quantity to increase productivity)
Improved technology
More investment
Capital deepening
What is capital deepening
An increase in the size of physical capital stock.
What is actual growth?
The percentage increase in a country’s real GDP and it is usually measured
annually. It is caused by increases in AD.
What is potential growth?
This is the long run expansion of the productive potential of an economy.
The potential output of an economy is what the economy could
produce if resources were fully employed.
What is comparative advantage?
A country has comparative advantage when it can produce goods and services at a lower opportunity cost than another.
What is actual growth?
Actual growth is the percentage increase in a country’s real GDP and it is usually measured
annually. It is caused by increases in AD.
What is potential growth?
The potential output of an economy is what the economy could produce if resources were
fully employed.
What is a negative output?
When the actual level of output is less than the
potential level of output.
What are the consequences of a negative output gap?
Downward pressure on inflation.
Unemployment
Spare capacity
What is a positive output gap?
When the actual level of output is greater than the
potential level of output.
What are the reasons for an consequences of a positive output gap
Resources being used beyond normal capacity e.g. overtime.
Upward pressure on inflation.
If productively is growing.
What are the difficulties with measure the output gap
Difficult to estimate the trend in a series of data.
The structure of the economy often changes.
Changes in the exchange rate might offset some inflationary effects of a positive output gap.
Data is not always reliable
What are the characteristics of a boom?
High rates of economic growth
Near full capacity or positive output gaps
(Near) full employment
Demand-pull inflation
Consumers and firms have a lot of confidence, which leads to high rates of
investment
Government budgets improve, due to higher tax revenues and less spending on
welfare payments
What are the characteristics of a boom?
High rates of economic growth
Near full capacity or positive output gaps
(Near) full employment
Demand-pull inflation
Consumers and firms have a lot of confidence, which leads to high rates of
investment
Government budgets improve, due to higher tax revenues and less spending on
welfare payments
What are the characteristics of a reccession?
Negative economic growth
Lots of spare capacity and negative output gaps
Demand-deficient unemployment
Low inflation rates
Government budgets worsen due to more spending on welfare payments and lower
tax revenues
Less confidence amongst consumers and firms, which leads to less spending and
investment
What are the costs of economic growth on consumers?
Greater inequality, low and fixed incomes
High demand pull inflation
Shoe leather costs, more time finding best prices
Law of diminishing returns
What are the costs of economic growth on consumers?
Greater inequality, low and fixed incomes
High demand pull inflation
Shoe leather costs, more time finding best prices
Law of diminishing returns
What are the benefits of economic growth on consumers?
Average consumer income increase, more people employed and wages increase.
Greater consumer confidence and higher living standards.
What are the costs of economic growth on firms?
Menu costs, keep changing prices due to inflation
What are the benefits of economic growth on firms?
More profits, increases investment. Higher business confidence.
Investment leads to new technologies to improve productivity.
Economies of scale as firms grow.
Growth in export markets.
Greater competition making them more productive and efficient.
What are the costs of economic growth on government?
Increase spending on healthcare due to consumption of demerit goods increases
What are the benefits of economic growth on government?
Budget might improve, less people require welfare payments and more tax revenue.
What are the costs of economic growth on current and future living standards?
Damage to the environment in long run, due to increase in negative externalises from consumption and production.
What are the benefits of economic growth on current and future living standards?
As incomes increase, people might show more concern for the environment.
Economic growth leads to development of greener technology.
Higher average wages.
Public services improve, since governments have more money from tax revenue. Increased education and life expectancy.
What are the 7 main macroeconomic objectives?
Sustainable economic growth around 2.5%
Low unemployment around 3% for frictional.
Low and stable inflation around 2%.
Balance of payments equilibrium on current account.
Balanced government budget.
Protection of the Environment
Greater income equality.
What is a monetary policy?
A monetary policy is used by the Central bank to control the flow of money, this is done using interest rates and quantitative easing.
How are interest rates used as a demand side policy?
Monetary Policy Committee (MPC) alters interest rates to
control the supply of money.
The bank controls the base rate, which ultimately controls the interest rates
across the economy.
When interest rates are high, the reward for saving is high and the cost of
borrowing is higher. This encourages consumers to save more and spend less,
and is used during periods of high inflation.
How is QE used as a demand side policy?
This is used by banks to help to stimulate the economy when standard
monetary policy is no longer effective. This has inflationary effects since it
increases the money supply, and it can reduce the value of the currency.
What are the limitations of monetary policy?
Banks might not pass the base rate onto consumers.
Even if the cost of borrowing is low, banks may be unwilling to lend.
Interest rates will be more effective at stimulating spending and investment when consumer confidence and firm confidence is high.
How is government spending and taxation used as a demand side policy?
Fiscal policy aims to stimulate economic growth and stabilise the economy.
Governments can change the amount of spending and taxation to stimulate
the economy. The government could influence the size of the circular flow by
changing the government budget, and spending and taxes can be targeted in
areas which need stimulating.
What is expansionary fiscal policy and draw a graph to represent this.
This aims to increase AD. Governments increase spending or reduce taxes to
do this. It leads to a worsening of the government budget deficit, and it may
mean governments have to borrow more to finance this.
What is delationtionary fiscal policy and draw a graph to represent this.
This aims to decrease AD. Governments cut spending or raise taxes, which
reduces consumer spending. It leads to an improvement of the government
budget deficit.
What is a budget deficit?
When expenditure exceeds tax receipts in a
financial year.
What is a budget surplus?
When tax receipts exceed expenditure.
What is debt?
. The debt is the accumulation of the government deficit over time. It is the amount
the government owes.
What is a deficit?
The deficit (or surplus) is the difference between expenditure and revenue at any one point.
What are the limitations of fiscal policy?
Imperfect information about the economy. It could
lead to inefficient spending.
Time lag
Borrows from private sector, there are fewer funds available for the private sector causing crowding out.
Depends on size of multier.
Interest rates.
What is the macroeconomic objective trade off between economic growth and inflation?
A growing economy is likely to experience inflationary pressures on the average
price level.
This is especially true when there is a positive output gap and AD
increases faster than AS.
What is the macroeconomic objective trade off between economic growth and the current account?
During periods of economic growth, consumers have high levels of spending.
Have high MPM leading to worsening of current account.
However, export-led growth, such as that of China and Germany, means a country
can run a current account surplus and have high levels of economic growth.
What is the macroeconomic objective trade off between Economic growth and the environment?
High rates of economic growth are likely to result in high levels of negative
externalities, such as pollution and the usage of non-renewable resources.
What is the macroeconomic objective trade off between unemployment and inflation?
In the short run, there is a trade-off between the level of unemployment and the
inflation rate.
As economic growth increases, unemployment falls due to more jobs being created.
However, this causes wages to increase, which can lead to more consumer spending
and an increase in the average price level.
What are the potential policy conflicts and trade offs?
Environment vs competitiveness
Progressive taxes vs inflation
Fiscal vs monetary policy
Interest rate vs inequality
What us a market based policy?
Market-based policies limit the intervention of the government and allow the free market to eliminate imbalances. The forces of supply and demand are used.
What is a supply side policy?
Supply-side policies aim to improve the long run productive potential of the
economy.
What is an interventionist policy?
Interventionist policies rely on the government intervening in the market.
What are market based policy examples?
To increase incentives (lower income and corp tax)
To promote competition (deregulation or privatisation)
To reform the labour market (lower NMW, reducing trade union power)
What are market interventonist examples?
To promote competition (stricter government policy to help reduce monopoly power)
To reform the labour market (subsidisation)
To improve skills and quality of the labour force (education spending, subside training, spending on healthcare)
Improve instracture
What are the strengths and weakness of supply side policies.
Supply-side policies are the only policies which can deal with structural unemployment, because the labour market can be directly improved with education
and training.
Demand-side policies are better at dealing with cyclical unemployment, since they
can reduce the size of a negative output gap and shift the AD curve to the right.
There are significant time lags associated with supply-side policies.
Market-based supply-side policies, such as reducing the rate of tax, could lead to a more unequal distribution of wealth.
