Macroeconomic Performance Year 2

Question 1

Economic Growth

Answer 1

Economic growth is defined as the increase in the real value of goods and services produced as measured by the annual percentage change in real Gross Domestic Product (GDP).
Economic growth is also defined as a long-run increase in a country’s productive capacity / potential national output.

Question 2

Factor payment

Answer 2

Factor payments are what the firm pays for the use of the factors of production. From the firm’s perspective, factor payments are costs. From the owner of each factor’s perspective, factor payments are income.

Question 3

Short-run and Long-run Growth

Answer 3

Short-run growth is simply an increase in a country’s ‘gross domestic product’ or ‘GDP’, whereas long-run growth is an increase in the country’s productive capacity. When thinking in terms of an AD-AS diagram, short run growth may be shown by an outward shift in aggregate demand which leads to an increase a long the “GDP” axis. Long run growth may be shown by an outward shift in LRAS, as this shows an increase in the country’s productive capacity.

Question 4

Inflation

Answer 4

Inflation is a sustained rise in an economy’s general price level. This means that, on average, the prices of goods and services are going up over time. As the price level rises each pound or dollar buys fewer products. This means the real value or purchasing power of money falls.

Question 5

Deflation

Answer 5

Deflation is a sustained period when the general price level for goods and services is falling. This means that a weighted basket of goods and services is becoming less expensive over time.

Question 6

Disinflation

Answer 6

Disinflation refers to a slowdown or a fall in the annual rate of price inflation. Consumer prices are still increasing, but more slowly. This drop in the inflation rate may be temporary in nature.

Question 7

Demand-Pull inflation

Answer 7

This increased demand is “pulling” up prices. Employment is rising also which means consumers have more disposable income. Gasoline demand and prices are rising as more employees drive to work. Airline tickets and hotel rooms are also rising as pent-up consumers increase travel.

Question 8

Cost-Push inflation

Answer 8

Cost-push inflation occurs when overall prices rise (inflation) due to increases in production costs such as wages and raw materials.

Question 9

Quantity theory of money

Answer 9

MV=PT
The quantity theory of money states that there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold. It is a theory supported by monetarists. They argue that if the money supply rises faster than the rate of growth of real output, then there will be inflation. If the money supply increases in line with real output then there will be no inflation.

Question 10

Fisher equation

Answer 10

MV=PT (in practise T is hard to measure so often substituted for Y which is equal to national output). Monetarists believe that V is fixed because the rate at which money circulates is determined by institutional factors. Also believe output Y is fixed. They state it may vary in the short run but not in the long run.
Evaluation:
If LRAS shifts prices may not rise in response to an increase in money supply because a lack of confidence might mean that the increase in money supply doesn’t cause an increase in transactions. If there is spare capacity the increase in transactions may be permanent.

Question 11

Inflation expectations

Answer 11

high inflation drives up inflation expectations, causing workers to demand wage increases to make up for the expected loss of purchasing power. When workers win wage increases, businesses raise their prices to accommodate the increase in wage costs, driving up inflation.

Question 12

Wage-price spiral

Answer 12

A wage price spiral is a situation where workers bid for higher wages because they have seen their real income eroded by fast-rising prices. This can lead to a further burst of cost-push inflation in an economy. It was a feature of stagflation in the 1970s and 1980s.

Question 13

Fiscal drag

Answer 13

Fiscal drag can occur because most tax systems use fixed income brackets, which means that as a taxpayer’s income increases due to inflation, a larger portion of their income may be subject to higher tax rates. This can lead to an increase in tax revenue for the government, even if tax rates have not been changed.

Question 14

Shoe leather costs

Answer 14

Shoe-leather costs refer to the time and effort it takes you to minimize the impact of inflation on your finances. The term comes from the physical shoe leather that people would wear out while making repeated trips to the bank.

Question 15

Menu costs

Answer 15

Menu costs are the costs that a business faces when it decides to change its prices.
Menu costs are one explanation for price-stickiness, a core tenet of New Keynesian economic theory.
Price-stickiness describes prices that do not adjust in response to macroeconomic changes.
Prices that do not change with inflation can contribute to a recession.
Companies can reduce menu costs by developing a wise pricing strategy so that fewer changes are necessary.

Question 16

SRPC

Answer 16

The short-run Phillips curve is a representation of this relationship in the short-term, where inflation and unemployment are inversely related. The short-run Phillips curve states that when unemployment is low, inflation tends to be high, and when unemployment is high, inflation tends to be low.

Question 17

Hysteresis

Answer 17

Hysteresis is a general term that means the history of a system affects the future of the system. In unemployment, hysteresis would mean that a history of being unemployed in the past may make a worker more likely to be unemployed in the future. Mankiw (2001) argues that hysteresis does exist with unemployment. If unemployment levels are above the Natural Rate of Unemployment for a long time, than the Natural Rate of Unemployment seems to rise.

Question 18

Stagflation

Answer 18

This is an increase in both unemployment and inflation.
A shift in the Phillips curve is caused by supply shocks and changes in inflationary expectations.
Over long periods, when aggregate supply shifts, the downward-sloping Phillips curve can shift so that unemployment and inflation are both higher.

Question 19

Money Illusion

Answer 19

Money illusion is the belief that money has a fixed value and the effects of inflation are ignored. Because of money illusion, during inflation, individuals may perceive an increase in nominal income as higher welfare – when this is actually an illusion and their real spending power has not changed because prices have risen at the same rate as wages.

Question 20

The Lawson boom

Answer 20

The Lawson boom of the late 1980s was a classic example of a ‘boom and bust’ economic cycle. The late 1980s were a period of rapid economic expansion. This was caused by rising house prices, tax cuts, lower interest rates and high confidence.
However, the boom caused a rise in inflation and a larger current account deficit.
Policies to tackle this inflation caused the recession of 1991-92.

Question 21

Automatic stabilisers

Answer 21

Automatic stabilizers are ongoing government policies that automatically adjust tax rates and transfer payments in a manner that is intended to stabilize incomes, consumption, and business spending over the business cycle.