How Economies Operate

Question 1

List the factors of production and their outputs.

Answer 1

Land: Rent
Labour: Wages
Capital: Interest
Enterprise: Profit

Question 2

What is GDP?

Answer 2

The total number of goods or services produced by an economy in a given year. Also measures the total income of a society from the production of goods and services.

Question 3

Outline briefly how goods and services are distributed throughout an economy?

Answer 3

• Individuals are assigned a certain level of income that commands them for a certain proportion of the output produced.
• Individuals can exchange this outcome for other goods and services.
• Market economies do NOT distribute outputs evenly - it is a reward for an individual’s contribution to the production process.
  
  • Owners of natural resources, capital or entrepreneurial skills are paid based on the value of their inputs whereas workers are paid based on the value of their labour.
• Rent of land in the centre of the city, or labour of a highly skilled manager would involve a larger sum of money due to their higher demands and scarce supply.

Question 4

What are the factors that influence one’s level of wages?

Answer 4

• How much they work
• Skills
• Expertise
• Educational qualifications
• Bargaining power in wage negotiations with employers.

Question 5

What is the benefit of a system where higher skilled/educated people get paid more?

Answer 5

The benefit of this system (where greater skills, education and hard work is highly valued) provides incentives for individuals to obtain better skills and work harder to improve their share of output and thus improve the resource base and encourage innovation and technological advancement.

Question 6

Those who are unable to contribute to production processes due to illness, disabilities or age are disadvantaged. How does the government intervene to deal with this issue?

Answer 6

The government intervenes to correct inequitable market outcomes by taking money from higher-income earners through taxation and redistributing it to lower-income earners through social security payments.

Question 7

What is bartering?

Answer 7

The non-money exchange of goods and services.

Question 8

Define the business cycle.

Answer 8

The fluctuations in the level of economic growth of an economy due domestic or international factors.

Question 9

What are the characteristics of downturns in the business cycle?

Answer 9

Falling production of goods and services
Falling levels of consumption and investment
Rising unemployment
Falling income levels
Falling quality of life

Question 10

What are the characteristics of peaks in the business cycle?

Answer 10

• Upper turning point where the economy has grown due to its capacity, with income, employment and output at their maximum.
  
  • Inflation rises due to scarcity of productive resources and factor prices being bid up by competing users

Question 11

What are the negative impacts of rapid economic growth?

Answer 11

• High inflation raises the cost of living
• Lenders raise interest rates (inflation means that money is losing value, so banks seek to maintain the real value of amounts owed to them), which can cause economic growth to fall in the future. The higher the rate of inflation, the higher interest rates.
• High output and consumption can place enormous strain on the environment.
• A shortage of productive resources (land, labour, capital and enterprise) can prevent economic growth in the future.

Question 12

Explain why high interest rates is a bad thing for the economy.

Answer 12

Roughly 1/3 of households have a mortgage that needs to be repaid. A lot of those loans have variable interest rates. When the reserve bank raises interest rates, your interest rate will also increase and vice versa. If all those households are no longer able to spend their money on goods and services and instead must dedicate it to loan repayments, there will be an economic downfall.

Question 13

What are counter-cyclical policies?

Answer 13

Counter-cyclical policies are the efforts of the government to smooth out the business cycle to ensure society is not faced with the negative impacts of both a peak or a trough. An example is setting minimum wages, and adjusting them to suit the costs of living during a particular point in time.

Question 14

Distinguish between a closed and an open economy.

Answer 14

A closed economy is one where there is no overseas sector therefore no international trade.
An open economy is one where there is an overseas sector hence there is international trade.

Question 15

Activity: Draw the 5 sector circular flow of income.

Answer 15

Check images.

Question 16

Why do lenders increase interest rates during a peak or upswing?

Answer 16

During a peak or upswing, inflation begins to rise. When inflation occurs, the value of money decreases. Lenders increases the interest rate for loan repayments to maintain the true value of money owed to them.

Question 17

When is an economy considered to be in a recession?

Answer 17

An economy is considered to be in a recession if it is experiencing a fall in economic growth for two consecutive quarters.

Question 18

Why does unemployment rise during a trough or a downturn?

Answer 18

Because consumers are now spending less on goods/services, businesses will need to stop some production processes - they will cut out jobs that are no longer necessary, causing for many to become unemployed.

Question 19

Outline how the relationship between leakages and injections affects economic activity.

Answer 19

If leakages > injections: the level of economic activity will fall (i.e economic decline)
If injections > leakages: level of economic activity will rise.

Question 20

What is the difference between a deficit and a surplus?

Answer 20

• A deficit (G > T) - expansionary
• A surplus (T > G) - contractionary
• balanced budget (T = G) - neutral

G: Government spending, T: Taxation

Question 21

Distinguish between leakages and injections giving an example of each.

Answer 21

Injections refer to the introduction of money into the circular flow of income, such as investments. Leakages refer to the withdrawal of money from the flow, such as imports.

Question 22

Distinguish between equilibrium and disequilbrium.

Answer 22

Equilibrium occurs when leakages (STM) = injections (IGX).

Disequilibrium occurs when leakages and injections are not equal, i.e one is greater than the other.

Question 23

Explain the two ways in which an economy in disequilibrium can return to equilibrium.

Answer 23

1. If leakages > injections, economic decline occurs; households save less, pay less tax, less imports. Thus leakages will decrease until they amount to injections, resulting in equilibrium but at a lower level.
2. If injections > leakages, economic growth occurs; leakages increase to amount to injections and equilibrium is restablished at a higher level.