How the Economy Works Flashcards
What are the factors influencing interest rates?
The factors influencing interest rates are:
- Economic growth - rates go up
- Unemployment - rates go down when high
- Wage inflation - rates go up
- Exchange rate
- House prices
- Consumer confidence
What factors affect how people spend?
The factors that affect how people spend are:
- Age
- Gender
- Habits
- Taxation levels
- Wealth
- Consumer confidence
- Interest rates
What factors have recently affected consumer spending?
The factors that have recently affected consumer spending are:
- The market crash 2007/2008 caused real incomes to fall, and therefore spending to fall
- Greater availability of credit
- People are conscious of consuming healthily
- Changes in technology
- Social patters (e.g. fewer children so more disposable income to spend on other items)
What factors impact borrowing?
The factors that impact borrowing are:
- Interest rates
- A person’s relative wealth
- The availability of credit
What are the impacts of a rise in interest rates on consumers?
The impacts on consumers are:
- People will be encouraged to save more as the reward is greater
- People are less likely to take out loans as the cost of borrowing has risen
- Monies paid into investments like shares are likely to decrease as people are more likely to put money into savings accounts
- People are less likely to spend and more likely to save
What are the impacts of a fall in interest rates on consumers?
The impacts on consumers are:
- People will be encouraged to save less as the reward has decreased
- People are more likely to take out loans as the cost of borrowing has decreased
- People are more likely to invest in shares
- People are more likely to spend and less likely to save
What are the impacts of a rise in interest rates on producers?
The impacts on producers are:
- Producers are likely to save more as the reward has increased
- They are less likely to take out loans as the cost of borrowing has increased
- Producers are less likely to invest and borrow money to expand their business or buy machinery
What are the impacts of a fall in interest rates on producers?
The impacts on producers are:
- Producers are less likely to save as the reward has decreased
- They are more likely to take out loans as the cost of borrowing has decreased
- Producers are more likely to invest and borrow money to expand their business or buy machinery
What factors determine investment?
The factors that determine investment are:
- Future expectations (firms must meet demand if it will rise in the future)
- Economic outlook (firms must meet the demands of a wealthier society if the economy grows)
- If the cost of goods is likely to increase or decrease
- Technological change (if technology improves businesses will invest to be more efficient)
What are the main areas of government spending?
The main areas of government spending are:
- Social protection
- Health
- Education
- General public services (transport, housing, social services)
- Defence
- Public order and safety
- Local government
What are the four government objectives?
The four government objectives are:
- Maintaining full employment
- Ensuring price stability
- Achieving economic growth
- Having a balance of payments
How does the government attempt to maintain full employment?
The government attempt to maintain full employment by supporting businesses to ensure they can employ people and helping individuals to attain the skills they need to become employable
Why does the government try to ensure price stability?
The government attempt to ensure price stability as steady rise in prices is often an indication of economic growth, but if wages are below the rate of inflation, in “real terms” this can create uncertainty in the economy. Individuals will reduce spending on consumption and businesses may reduce investment.
Why does the government attempt to achieve economic growth?
The government attempts to achieve economic growth as it allows the government to provide more and more public services to the population
What does the government attempt a balanced current account on the balance of payments?
The government attempts a balanced current account on the balance of payments as they wish to achieve an equilibrium between the inflows of money from exports and the outflows of money from imports, which are reflected in the current account
How are the government objectives quoted in the UK?
The government objectives are quoted in the UK as follows:
- Full employment is a target of 4% rate of unemployment
- Ensuring price stability is keeping an inflation rate of 2%
- Economic growth is targeted at a sustainable level of approx. 2.5% per annum
- The current account should not permanently be in deficit
Aside from the main four, what other objectives do the government hold?
Aside from the main four, the government also attempts to:
- Reduce inequality (reduce the gap between the lowest and highest paid workers, as well as the least and most wealthy households)
- Managing environmental change (e.g. attempting to ensure that economic activity has a less negative impact on the environment)
In what ways do government objectives conflict each other?
Government objectives conflict each other in the following ways:
- Maintaining full employment versus price stability: Full employment will increase spending power and demand, thus causing an increase in prices
- Economic growth versus price stability: Stable prices may not encourage businesses to increase output, and hence GDP as there is less of an incentive for profit
- Economic growth versus balance of payments: Economic growth may result in higher incomes and increased spending power, increasing demand for goods an services abroad. More spending on imports will increase the imbalance on the current account
- Economic growth versus reducing inequality: Economic growth is achieved through thriving businesses, often meaning greater rewards for entrepreneurs to a greater extent than other employees. This can result in an increased gap between the highest and lowest earners.
What is economic growth?
Economic growth is the growth of GDP over time
What is GDP?
GDP is the total market value of goods and services produced in an economy in a year
What is the equation for rate of economic growth?
Rate of economic growth = (Change in GDP between years 1 and 2/GDP in year 1) x 100
What is GDP per capita?
GDP per capita is a measure of the average income in a country
What is the equation for GDP per capia?
GDP per capita = GDP/Population
What supply-side factors effect economic growth
Supply-side factors effecting economic growth are:
- Investment in capital goods and human knowledge
- Technology
- Education and training
- The size of workforces
- Labour productivity
- Availability of natural resources
What government policies affect economic growth?
Government policies affecting economic growth are:
- Investment in infrastructure
- The amount of government intervention
- The macro management of the economy
What are the benefits of economic growth?
The benefits of economic growth are:
- A rise in living standards
- Higher employment
- A reduction in poverty
- An increase in the welfare of the population
What are the costs of economic growth?
The costs of economic growth are:
- Environmental costs
- Air pollution
- Contribution to global warming
- Congestion
- Reduced quality of life (mental health)
- Inequalities of income and wealth
What is real GDP?
Real GDP = level of GDP - rate of inflation
What is employment?
Employment is the use of labour to produce goods and services in an economy
What is unemployment?
When workers willing and able to work at current wage rates are unable to find paid employment
What is the labour force?
All people in work and those registered as unemployed
What is the level of unemployment?
The level of unemployment is the number of people unemployed (the claimant count)
What is the rate of unemployment
The rate of unemployment is the number of people unemployed as a percentage of the labour force, i.e. rate of unemployment = (Number of people unemployed/Labour force) x 100
What are the four causes of unemployment?
The four causes of unemployment are:
- Seasonal unemployment - regular changes in the demand for labour at different times of year
- Frictional unemployment - workers feel short spells of unemployment as they move between jobs
- Structural unemployment - arises from the mismatch of skills and job opportunities as the pattern of labour demand in the economy changes (usually due to long term decline in industries like coal mining)
- Cyclical unemployment - caused by a fall in general levels of demand which could lead to businesses making workers redundant because they lack confidence demand will recover
What is inflation?
Inflation is a persistent rise in he general price level of goods and services
What is cost push inflation?
Cost push inflation is when an increase in the cost of production forces firms to increase the prices they charge to consumers to compensate for increased costs
What is demand pull inflation?
Demand pull inflation is when a rise in demand from consumers and businesses causes shortages in the short-term, and to ration demand, prices may rise, causing inflation
What is monetary inflation?
Monetary inflation is when there is too much money available in the economy, e.g. due to a greater availability of credit, meaning consumers will have more access to funds, which will increase spending and forcing prices to increase
What is the balance of payments?
The balance of payments is a record of the UK’s transactions with the rest of the world, made up the current account, financial account, and capital account
What four key areas make up the current account?
The four key areas are:
1 and 2. Trade in goods and services (balance of trade/trading account)
3. Primary income
4. Secondary income
What is income?
Income is the reward for labour or for owning an asset
What are the main sources of income?
The main sources of income are:
- Wages
- Interest from savings
- Income from pensions/life insurance
- Dividends from owning shares
- Rent income from owning property
What is wealth?
Wealth is a stock of assets with a market value, for example savings from banks, pensions, household assets (computers, furniture, etc.), pension fund contributions
How is income distributed in the UK?
- The bottom 10% of the population as an average wage of £9,644 per year
- The top 10% has an average wage of £83,875 per year
- The top 1% has an average wage of £253,927 per year
Why is income distributed unequally in the UK?
- Wage differentials
- Sections of the population have more assets than others, due to wealth, so will earn more income from those
- The poorest households rely on pensions and benefits for income. Unemployment is a factor in unequal income distribution
- Age: those in the middle age groups earn the highest incomes
- The gender pay gap
Why is there an unequal distribution of wealth?
Due to different attitudes to spending and saving over time
What is relative poverty?
Having less than 60% of the median income
What two methods do the government use to redistribute income and wealth?
- Taxation: Progressive tax system means those on lower incomes pay a lower rate
- Government expenditure: The government spend money on benefits, trading schemes, and other supply-side policies
What is fiscal policy?
Fiscal policy is the use of taxation, government expenditure and government borrowing to affect the levels of income and expenditure in the economy
How does fiscal policy affect income and expenditure
- Public sector jobs - Central and local government employ and pay 5 million people, wages that contribute towards consumption and economic growth
- Private sector jobs - Central and local government contract out activities to private sector companies, ensuring jobs and wages for private sector workers
- Public sector expansion - Government subsidies and grants allow businesses to bid for government funds, which will lead to greater output and hence economic growth
- Welfare benefits - The UK’s benefit safety net means the government grants funds to those who cannot work and earn in order to allow a level of consumption, eliminating absolute poverty
- Changes to tax - Changes to the rate of taxation have an immediate effect on income and expenditure (reduction in income tax –> more disposable income –> more demand in economy is generated). Tweaking corporation tax can encourage investment in the UK.
- Government expenditure - Since the coalition, the government has attempted to reduce the rate of increase in national debt by reducing its expenditure
Examples of Supply-Side Policies
- Reducing benefits
- Reducing income tax
- Privatisation
- Reducing corporation tax
- Reduced trade union power
- Regulation and deregulation