Growth Flashcards
define inflation
a general increase in prices and fall in the purchasing power
define economic growth
An increase in GDP over a period of time
Sustained recovery
A steady rise in GDP following a recession
Reccession
In the UK a recession is a period of negative economic growth for two consecutive quarters.
Growth rate
the rate at which a nation’s Gross Domestic product (GDP) changes/grows from one year to another
4 problems with growth?
- Inflation (caused by an increased AD)
- environmental problems ->Quality of life can decrease if pollution is caused.
- Potential widening of equality
- Current account deficit
Postive output gap
Economy is operating at full capacity
Negative output gap
Economy is operating with spare capacity
Current account deficit
When a country imports more than exports. The UK is susceptible to a current account deficit during high growth because the UK has a high marginal propensity to import.
What is the problem with a current account deficit
- depreciating exchange
- cost push inflation
- firms may be less able to compete
however in the long term the current account my recover assuming the marshal Lerner condition holds
Why is environmental damage problematic?
Air/land/water pollution causes health problems
- damage the productivity of land (as more non renewable resources are used up) and seas. Causing generational inequality
Increased pollution from economic growth will cause health problems such as asthma and therefore will reduce the quality of life.
3 ways Environmental damage is being mitigated
subsidised renewable energy
Tradable pollution permits
taxes on pollutants
4 reasons why is inflation problematic?
- As it decreases purchasing power of consumers meaning some basic necessities may be unable to access
- it decreases confidence -> firms may delay spending to wait for prices to fall
- current account deficit may cause a depreciation of the pound making imports more expensive
- Can cause a wage price spiral which could lead to more unemployment as firms struggle due to rising costs
What is the UK’s Inflation target
1-3%
The multiplier effect
The multiplier effect refers to the increase in final income arising from any new injection of spending.
Relationship between how AD rises as a result of injections
The accelerator effect
states that an increase in the rate of economic growth will cause a correspondingly larger increase in the level of investment.
- there is an increase in consumer demand
- firms get close to full capacity
- invest in factors of production to increase spare capacity to prepare for an increase in AD.
How to calculate the multiplier?
change in real GDP/ change in injections
1/size of leakages
1/1- marginal propensity to consume
What is MPC
The marginal propensity to consume (MPC) measures the proportion of extra income that is spent on consumption
How is MPC calculated
consumption/change in disposable income
for example, if an individual gains an extra £10, and spends £7.50, then the marginal propensity to consume will be £7.5/10 = 0.75.
c on ice
Leakages?
Taxes
Imports
saving
Injections
Government spending
Exports
Investment
5 Benefits of economic growth
- Higher incomes
- The govt can have greater tax revenues as a result
- Lower unemployment. With higher output and positive economic growth, firms tend to employ more workers creating more employment.
- Better confidence may cause increased investments
- helps satisfy some of the unlimited needs and wants
Name 4 causes of demand sided growth
what increases AD
- Higher real incomes
- Lower interest rates
- Increased govt spending
- cuts in taxes
Evaluation of AD
- If inflation is too high it can cause a wage price spiral (so you want low AD)
- Cyclical unemployment can cause structural unemployment-> due to hysteresis (so you want high AD)
- Structural unemployment can fall with high AD in there is increased investment and in training. (so you want high AD)
Benefits of a weak pound
A weak pound makes imports more expensive and British exports cheaper.
This means the UK can benefit from greater injections due to the increase in exports
(Dependant on the PED of the majority of the exports and imports is elastic)
Causes of weak pounds
Quantitative easing-> increasing the supply of money decreases the value
current account deficit
how is long run growth caused
Increases in the quantity and quality of FOPS
capital- investing in more efficient tech
land- discovery of new resources
labour- increasing size of labour force (by lowering taxes) or better education
What is long run growth
when there is an increase in production possibilities of a nation (causing an outward shift in ppc)
What is short run growth
increase in output (economy still operates within the ppc
how does a current account deficit cause a weaker pond
Will mean that the demand for pounds to buy UK exports is lower than the UK consumers’ demand for foreign currency to buy imports. The value of the pound will fall
why may the demand pull inflation may be a small problem for the UK
We are still in the early stages of an economic recovery and there is plenty of spare capacity
2 ways in which economic growth can widen inequality
- In recent years, in the UK, we have seen faster wage growth for highly paid jobs than unskilled jobs.
- Interest-bearing wealth. The wealthy gain interest and dividends from their assets. This rent, interest and dividends can be used to re-invest in increasing their wealth
What does the lras macro model assume
- Says that the economy is opertating at a positivity output gap and that wages and prices are flexible.
- wages increase with inflation
- macro economy will correct itself with changes in demand
Why is the Keynesian as flat at the start
- As firms are not willing to offer lower prices as they seek to aim profit
- as workers are not willing to work for a lower wage
What causes a shift is sras
changes costs of factors of production
what causes a shift in lras
quantity and quality of fops for an improvement in productive efficiency
What is hysteresis
when workers become unskilled as a result of long term periods of unemployment
Name 3 market based supply side policies
- trade liberalisation
- deregulation
- privatisation
The aim is to increase competition
WHen does spare capacity exist
when the current level of output is below the maximum possible in the short run. Meaning spare labour and capital inputs are available to use
how does demand pull inflation occur
- to prevent increasing demand from outstripping supply
- they will increase output and need to employ more
- in doing so resources will become more scarce
- as a consequences factor prices will rise as firms compete for them
- to maintain profit margins firms raise prices
but in doing so business will pay extra as a result of the law of diminishing returns and prices will rise as a result
what is discretionary income
income after necessities are bought and tax is paid
what is disposable income
income after tax
law of diminishing returns
any increase in production over the optimum level will result in smaller levels of output
how does cost push inflation occur
as supply shifts inwards firms will be unable to operate at the same cost and prices will have to rise as a result
what is the transmission mechanism
is the way in which changing the monetary policy can effect AD
evaluation of monetary policy
- there is around an 18 month time lag
how does an expansionary monetary policy affect AD
- lower interest rates means home owners paying a variable mortgage have to pay less of their income on repayments of borrowing. This increases their discretional income. 46% of people are on variable mortgages in the UK
- as it becomes cheaper to get a mortgage home demand for houses increase and home owner feel more wealthy (wealth effect) and need to save less.
- low interest makes investment easier as the opportunity cost goes down and the returns from investing are higher than saving
- what is the liquidity trap
- why may it occur
(an argument that Keynesian economists will use)
- When monetary policy becomes ineffective because, despite zero/very low-interest rates, people want to hold cash rather than spend or buy illiquid assets.
This may occur because when the interest rate has been low everyone will have got a loan from the bank. any further decrease in the interest rate isn’t likely to increase AD as the extra spending has already occurred
what does the success of monetary policy depend upon?
3 things
- amount of spare capacity
if the economy is operating at full capacity an fall in interest rates will result in inflation instead of growth. - confidence
if consumers are unconfident as a result of a major political/economic change can lead to uncertainty such as lockdowns surrounding Corona virus they my be unwilling to borrow - the size of the decrease of interest.
if it is big it will have a bigger impact on AD - liquidity trap
why may the accelerator effect occur
- economies of scale. it is much more efficient to make a large investment to increase capacity rather than making incremental changes
- favourable economic conditions such as low interest rates
Purchasing power parity
the exchange rate at which a currency can buy you the same basket of goods for the same price in either country
how does the income effect impact high interest rates
If interest rates are high savers get more income from saving. Therefore giving them more to spend and spending may increase as a result
how does the substitution effect impact high interest rates
the opportunity cost of saving increases as saving becomes more profitable. Spending may decrease as a result
Nominal GDP
growth without adjustment for inflation
structural budget deficit
a budget deficit that occurs at full employment and capacity
EG investing in the HS2
cyclical budget deficit
a budget deficit that is dictated by the economic cycle
usually in a recession
what is a positive statement
one that can be proved and can be tested against facts
what is a normative statement
one based on opinion
what is capital
Capital goods are fixed assets which are used in the productive process in order to produce a finished ‘consumer’ good. Capital goods are not bought for their own utility
why may improved employment opportunities (as a result of economic growth) not always result in increased employment
depends on structural unemployment. many workers may have been unemployed for a long time and may have suffered from hysteresis as a result.
The government may be required to invest in supply side policies as a result.
what’s value judgement
A value judgement is an evaluative statement of how good or bad you think an idea or action is
what’s the institutional structure in the economy
the banking system
in the circular flow of income what three things are equal
income= output=expenditure
why may deflation be good
if it is benign. (caused by an outward shift in LRAS)
such as increased investment into the HS2 resulting in a decline in frictional unemployment
what type of GDP does the multiplier effect impact
nominal GDP
how does the bank identify when the economy is nearing or past full employment
when wage rates are increasing it suggests inflation is likely.
Firms may be unable to finance an increase in wages in the long term so they may increase prices
why may a fall in the bank rate translate to lower interest rates
This is because the reward for saving with the BOE falls and they may chose to loan it out as it is more profitable as a result.
Supply of loanable funds increases as a result.
why may monetary policy not be effective
- time lag (when the economy is unpredictable its hard to implement the monetary policy 2 years in advance to keep things stable).
- if consumers aren’t confident. during a recession they may be unwilling to take out a loan due to fears of failure of repayment if they are made unemployed.
- if the interest is already so low an further decrease in the interest may not translate into further consumption as everyone who has a loan has one (liquidity trap)
- if banks aren’t confident
what’s the difference between nominal and real GDP
Nominal GDP is the total value of all goods and services produced in a given time period. Real GDP is nominal GDP adjusted for inflation.
what is turkeys interest rate
14% (second highest in the EU)
This may encourage hot money outflows as wealthy earners seek to save in Turkey instead and the value of the pound will depreciate as a result
what’s inflation in the UK
9%
what inflation in France
5.8%
when is inflation good
- when it avoids deflation->inflation encourages consumers to spend as consumers fear prices may increase further in the future
- it can allow for wage adjustments (It is difficult to cut wages so by increasing wages of productive workers and keeping the unproductive workers wages constant it prevents unemployment)
give 3 reasons why deflation is bad
- sticky wages can lead to real wage unemployment. ->as workers resist nominal wage cuts (as they are used to seeing pay increases each year)
- discouraged consumer spending-> consumers will wait for further price cuts before buying their (luxury product) to save money
- increase in REAL interest rates causing consumers to save
how does malignant deflation occur
- As AD falls consumers become less willing and able to buy goods at the current price level.
- so therefore prices may fall in order to attract demand
- this may cause unemployment as firms seek to maintain profit margins they may cut costs
fiscal drag
when economic growth and inflation pushes workers into higher tax brackets
as inflation is 7% and tax bands remain constant when workers earn greater wages it may be worse for the consumer
the government is projected an 8 billion pound increase in tax if tax brackets remain fixed
why may government borrowing be justified
as bond yields are just 2% the government can afford to release bonds at this low price and pay little interest on them making the cost of debt relatively cheap
however you can also argue the other way and its becoming more expensive as bond prices are rising
what is quantative easing
when he government buys back their bonds from the private sector
this increases the supply of money which translates into lower interest rates
how to overcome the liquidity trap
they should use fiscal policy. as bond yields are at two percent the government can release new bonds with a relatively low coupon of just about 2% to finance government spending.
quantitative easing increases the supply of money and increases incentive for banks to loan out
