Macro Economics

Question 1

Causes for economic growth: (Demand AD = C + I + G +( X - M))

Answer 1

Higher real wages +C
Tax cuts +C
Devaluation +X -M
Government spending +G
Lower interest rates +I +C

Question 2

Causes for economic growth: (Supply-side (LRAS))

Answer 2

Increased investment
Higher labour productivity
Discover raw materials
Increase in labour force
Improved technology

Question 3

The government has four main macroeconomic objectives?

Answer 3

These aim to provide macro stability.

Economic growth, Minimising unemployment, Price stability, Stable balance of payments on current account. Additional ones are Balanced government budget, Greater income equality, Potential conflicts and trade-offs between the macroeconomic objectives

Question 4

Economic growth vs inflation

Answer 4

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.

Question 5

Economic growth vs the current account:

Answer 5

During periods of economic growth, consumers have high levels of spending. In the UK, consumers have a high marginal propensity to import, so there is likely to be more spending on imports. This leads to a worsening of the current account deficit. 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.

Question 6

Economic growth vs the government budget deficit

Answer 6

Reducing a budget deficit requires less expenditure and more tax revenue. This would lead to a fall in AD, however, and as a result there will be less economic growth.

Question 7

Economic growth vs the environment

Answer 7

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. This is because of more manufacturing, which is associated with higher levels of carbon dioxide emissions.

Question 8

Unemployment vs inflation:

Answer 8

In the short run, there is a trade-off between the level of unemployment and the inflation rate. This is illustrated with a Phillips curve.
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.

Question 9

GDP

Answer 9

GDP measures the quantity of goods and services produced in an economy (national output). In other words, a rise in economic growth means there has been an increase in national output. Real GDP is the value of GDP adjusted for inflation. For example, if the economy grew by 4% since last year, but inflation was 2%, real economic growth was 2%.

Question 10

Real GDP per capita

Answer 10

Real GDP per capita is the value of real GDP divided by the population of the country. Capita is another word for ‘head’, so it essentially measures the average output per person in an economy. This is useful for comparing the relative performance of countries.

Question 11

Consumer Prices Index and Retail Prices Index (CPI/RPI):

Answer 11

CPI and RPI are the measures of inflation in the UK. The Consumer Prices Index (CPI) measures household purchasing power with the Family Expenditure Survey. The survey finds out what consumers spend their income on. From this, a basket of goods is created. The goods are weighted according to how much income is spent on each item. Petrol has a higher weighting than tea, for example. Each year, the basket is updated to account for changes in spending patterns.
RPI is an alternative measure of inflation. Unlike CPI, RPI includes housing costs, such as payments on mortgage interest and council tax. This is why RPI tends to have a higher value than CPI.

Question 12

Measures of unemployment:

Answer 12

It is usually difficult to accurately measure unemployment. Some of those in employment might claim unemployment related benefits, whilst some of the unemployed might not reveal this in a survey. The Claimant Count, and The International Labour Organisation (ILO) and the UK Labour Force Survey (LFS).

Question 13

The two main measures of unemployment in the UK are:

Answer 13

The Claimant Count
This counts the number of people claiming unemployment related benefits, such as Job Seeker’s Allowance (JSA). They have to prove they are actively looking for work.

The International Labour Organisation (ILO) and the UK Labour Force Survey (LFS)
The LFS is taken on by the ILO.
It directly asks people if they meet the following criteria:
. Been out of work for 4 weeks
. Able and willing to start working within 2 weeks
. Workers should be available for 1 hour per week. Part time unemployment is included.
Since the part-time unemployed are less likely to claim unemployment benefit, this method gives a higher unemployment figure than the Claimant Count.

Question 14

Measures of productivity:

Answer 14

Productivity is defined as output per worker per period of time. It measures how efficient production is. Productivity increases if more output can be produced with fewer units of input.
For example, labour productivity is measured in the UK by output per hour. In the first quarter of 2015, it grew by 0.3%.

Question 15

Balance of payments on current account:

Answer 15

The balance of payments is a record of all financial transactions made between consumers, firms and the government from one country with other countries. It states how much is spent on imports, and what the value of exports is.
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.
Imports are goods and services bought from foreign countries, and they are negative on the balance of payments. They are an outflow of money.
The balance of payments is made up of:
- The current account
- The capital account
- The official financing account.
For the AS course, only the current account is focussed on.
The current account on the balance of payments is the balance of trade in goods and services.

Question 16

National income can also be measured by:

Answer 16

GrossNationalProduct(GNP)
Gross National Income (GNI)

Question 17

Gross National Product(GNP)

Answer 17

Gross National Product(GNP) is the market value of all products produced in an annum by the labour and property supplied by the citizens of one country. It includes GDP plus income earned from overseas assets minus income earned by overseas residents. GDP is within a country’s borders, whilst GNP includes products produced by citizens of a country, whether inside the border or not.

Question 18

Gross National Income (GNI)

Answer 18

Gross National Income (GNI) is the sum of value added by all producers who reside in a nation, plus product taxes (subtract subsidies) not included in the value of output, plus receipts of primary income from abroad (this is the compensation of employees and property income).

Question 19

The use and limitations of national income data to compare differences in living standards between countries

Answer 19

. GDP does not give any indication of the distribution of income. Therefore, two countries with similar GDPs per capita may have different distributions which lead to different living standards in the country.
. GDP may need to be recalculated in terms of purchasing power, so that it can account for international price differences. The purchasing power is determined by the cost of living in each country, and the inflation rate.
. There are also large hidden economies, such as the black market, which are not accounted for in GDP. This can make GDP comparisons misleading and difficult to compare.
. GDP gives no indication of welfare. Other measures, such as the happiness index, might be used to compare living standards instead or in conjunction with GDP.

Question 20

The circular flow of income

Answer 20

. Firms and households interact and exchange resources in an economy. Households supply firms with the factors of production, such as labour and capital, and in return, they receive wages and dividends.
. Firms supply goods and services to households. Consumers pay firms for these. This spending and income circulates around the economy in the circular flow of income, which is represented in the diagram above.
. Saving income removes it from the circular flow. This is a withdrawal of income. Taxes are also a withdrawal of income, whilst government spending on public and merit goods, and welfare payments, are injections into the economy.
. International trade is also included in the circular flow of income. Exports are an injection into the economy, since goods and services are sold to foreign countries and revenue in earned from the sale. Imports are a withdrawal from the economy, since money leaves the country when goods and services are bought from abroad.
. Full employment income is the total output of an economy when unemployment is minimised or is at the government target. This accounts for frictional unemployment.

Question 21

Injection

Answer 21

An injection into the circular flow of income is money which enters the economy. This is in the form of government spending, investment and exports.

Question 22

Withdrawal

Answer 22

A withdrawal from the circular flow of income is money which leaves the economy. This can be from taxes, saving and imports.

Question 23

Net injections

Answer 23

If there are net injections into the economy, there will be an expansion of national output.

Question 24

Net withdrawals

Answer 24

If there are net withdrawals from the economy, there will be a contraction of production, so output decreases.

Question 25

The downward slope of the AD curve can be explained by:

Answer 25

. Higher prices lead to a fall in the value of real incomes, so goods and services become less affordable in real terms.
. 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. This will discourage spending, since saving becomes more attractive and borrowing becomes expensive.

Question 26

A rise in AD is shown by a shift to the left in the demand curve (AD1->AD2). This rise in economic growth occurs when:

Answer 26

. 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. This is affected by anticipated income and inflation.
. If the Monetary Policy Committee lowers interest rates, it is cheaper to borrow and reduces the incentive to save, so spending and investment increase. However, there are time lags between the change in interest rates and the rise in AD, so this is not suitable if a rise in AD is needed immediately.
. Lower taxes mean consumers have more disposable income, so AD rises.
. An increase in government spending will boost AD.
. Depreciation in a currency means M is more expensive, and X is cheaper, so
AD increases. A decline in economic growth in one of the UK’s export markets
means there will be a fall in X, so AD falls.
. In the UK, most people own their houses. This means that a rise in the price
of houses makes people feel wealthier, so they are likely to spend more. This is the wealth effect.

Question 27

The AS curve:

Answer 27

. Aggregate supply shows the quantity of real GDP which is supplied at difference price levels in the economy.
. The AS curve is upward sloping because at a higher price level, producers are willing to supply more because they can earn more profits.

Question 28

Aggregate demand

Answer 28

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.

Question 29

The SRAS curve shifts when there are changes in the conditions of supply.

Answer 29

• The cost of employment might change, e.g. wages, taxes, labour
  productivity
• The cost of other inputs e.g. raw materials, commodity prices, the
  exchange rate if products are imported
• Government regulation or intervention, such as environmental laws
  and taxes, and business regulation. Business regulation is sometimes called ‘red tape’.

Question 30

Disposable income

Answer 30

Disposable income is the amount of income consumers have left over after taxes and social security charges have been removed. It is what consumers can choose to spend.

Question 31

Influences on consumer spending:
Interest rates

Answer 31

If the Monetary Policy Committee lowers interest rates, it is cheaper to borrow and reduces the incentive to save, so spending and investment increase. However, there are time lags between the change in interest rates and the rise in AD, so this is not suitable if a rise in AD is needed immediately. Lower interest rates also lower the cost of debt, such as mortgages. This increases the effective disposable income of households.

Question 32

Influences on consumer spending:
Consumer confidence

Answer 32

o 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. This is affected by anticipated income and inflation.
o If consumers fear unemployment or higher taxes, consumers may feel less confident about the economy, so they are likely to spend less and save more. This delays large purchases, such as houses or cars.

Question 33

Influences on investment:
The rate of economic growth

Answer 33

If growth is high, firms will be making more revenue due to higher rates of consumer spending. This means they have more profits available to invest.

Question 34

Influences on investment:
Business expectations and confidence

Answer 34

. If firms expect a high rate of return, they will invest more. Firms need to be certain about the future, otherwise they will postpone their investments.
. Also, expectations about society and politics could affect investment. For example, if a change in government might happen, or if commodity prices are due to rise, businesses may postpone their investment decisions.
. Keynes coined the term animal spirits when describing instincts and emotions of human behaviour, which drives the level of confidence in an economy.

Question 35

Influences on investment:
Demand for exports

Answer 35

. This is related to the rate of market demand. The higher demand is, the more likely it is that firms will invest. This is because they expect higher sales, so they might direct capital goods into the markets where consumer demand is increasing.

Question 36

Influences on investment:
Interest rates

Answer 36

. Investment increases as interest rates falls. This means that the cost of borrowing is less and the return to lending is higher.
. The higher interest rates are, the greater the opportunity cost of not saving the money.
. Moreover, high interest rates might make firms expect a fall in consumer spending, which is likely to discourage investment.

Question 37

Influences on investment:
Access to credit

Answer 37

. If banks and lenders are unwilling to lend, such as shortly after the financial crisis when banks became more risk averse, firms will find it harder to gain access to credit, so it is either more expensive or not possible to gain the funds for investment.
. Firms could use retained profits, however.
. The availability of funds is dependent on the level of saving in the economy.
The more consumers are saving, the more available fund are for lending, and therefore for investing.

Question 38

Influences on investment:
The influence of government and regulations

Answer 38

The rate of corporation tax could affect investment. Lower taxes means firms keep more profits, which could encourage investment.

Question 39

Fiscal policy

Answer 39

. Governments use fiscal policy to influence the economy. It involves changing government spending and taxation.
. Governments might spend on public goods and merit goods, as well as welfare payments.
. Fiscal policy is a demand-side policy, so it works by influencing the level or composition of AD.
. Discretionary fiscal policy is a policy which is implemented through one-off policy changes.
. Automatic stabilisers are policies which offset fluctuations in the economy. These include transfer payments and taxes. They are triggered without government intervention.
. The government might use expansionary fiscal policy during periods of economic decline.
This involves increasing spending on transfer payments or on boosting AD, or by reducing taxes.
. During periods of economic growth, governments might use contractionary fiscal policy by decreasing expenditure on purchases and transfer payments. Additionally, tax rates might increase. This reduces the size of the government budget deficit.

Question 40

The main influences on the (net) trade balances:
Real income

Answer 40

. 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.
. When consumers increase their spending, they consume more domestic products as well as more imports.
. During periods of economic decline, real incomes fall and historically, this has led to improvements in the UK’s current account.

Question 41

The main influences on the (net) trade balances:
Exchange rates

Answer 41

. A depreciation of the pound means imports are more expensive, and exports are cheaper, so the current account trade deficit narrows.
. Depreciations make the currency relatively more competitive against other currencies.
. However, it depends on which currency the pound depreciates against. If it is the dollar or euro, it is likely to have a more significant effect, than a currency which is not from one of the UK’s major trading partners.
. Moreover, the demand for UK exports has to be price elastic to lead to an increase in exports. If demand is price inelastic, exports will not increase significantly, and the value of exports will decrease.

Question 42

The main influences on the (net) trade balances:
State on the world economy

Answer 42

. 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.
. For example, the UK’s largest export market is the EU. If they face an economic downturn then demand for UK goods and services will fall, since consumers in the EU are less able to afford imports.

Question 43

The main influences on the (net) trade balances:
Degree of protectionism

Answer 43

. Protectionism is the act of guarding a country’s industries from foreign competition. It can take the form of tariffs, quotas, regulation or embargoes.
. If the UK employed several protectionist measures, then the trade deficit will
reduce. This is because the UK will be importing less due to tariffs and quotas
on imports to the UK.
. However, since protectionism leads to retaliation, exports might decrease
too, which undoes the effect of reduced imports.

Question 44

The main influences on the (net) trade balances:
Non-price factors

Answer 44

. The competitiveness of a country’s goods and services, which is influenced by supply-side policies, impacts how many exports the country has.
. 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.
. Moreover, trade deals and being part of trading blocs can influence how much a country exports. This either opens up a country to, or closes a country from, significant export opportunities.

Question 45

The SRAS curve shifts when there are changes in the conditions of supply. The price level and production costs are the main determinants of SRAS.

Answer 45

• The cost of employment might change, e.g. wages, taxes, and labour productivity. If costs increase, supply will shift inwards from SRAS1 to SRAS3.
• The cost of other inputs e.g. raw materials, commodity prices, and the exchange rate if products are imported. A stronger currency reduces the price of imports, so imported products will be cheaper. This would shift the AS curve outwards, from SRAS1 to SRAS2.
• Government regulation or intervention, such as environmental laws or green taxes and business regulation. Business regulation is sometimes called ‘red tape’.
• There could be a net outward migration of workers, which causes a ‘brain drain’ on the domestic economy, as skilled workers move elsewhere.
• If there is a fall in business capital spending, supply will fall.

Question 46

Factors influencing the long-run AS:

Answer 46

Technological advances, Changes in relative productivity, Changes in education and skills, Changes in government regulations, Demographic changes and migration, Competition policy