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Economy HL > Macroeconomics (3.5 - 3.7) > Flashcards

Macroeconomics (3.5 - 3.7) Flashcards

1
Q

Monetary policy

A

Carried out by the central bank and involves the control of money supply and interest rates to influence AD and fulfil macroeconomic objectives

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2
Q

Demand side policy

A

Government policy that aims to influence level of AD of the economy

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3
Q

Low and stable rate of inflation goal

A

Using monetary policy to achieve predetermined level of inflation. BY increasing transparency of central bank in controlling inflation, stable economic environment for consumers and producers created

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4
Q

Low unemployment goals

A

May stimulate economic by reducing interest rates which reduces cost of borrowing for firms and households encouraging investment and consumption

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5
Q

Reduce business cycle fluctuations

A

Used to influence level of economic activity

Economic downturn: Interest rates lowered to stimulate economy

Economy booming: Interest rates raised to lower inflationary pressure

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6
Q

External balance goals

A

Refers to value of economy’s expert revenue being equal to its import expenditure. Interest rates can influence exchange rates which affects value of exports and imports

Lower interest rates -> Currency is less attractive for foreign buyers -> Exchange rate decreases -> Demand for export increases -> Export revenue > Import expenditure -> Inflationary pressure as more money flows in

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7
Q

Money multiplier formula

A

1 / Reserve ratio

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8
Q

Factors for setting interest rate

A
  • Exchange rate
  • Property prices
  • Rate of growth and nominal wages
  • State of the economy
  • Business confidence levels
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9
Q

Open market operations

A

Buying and selling of governments bond a central bank to control money supply and interest rates. If central bank wants expansionary monetary policy, can buy government bonds.

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10
Q

Minimum reserve requirement

A

Required percentage of despotism that commercial banks keep in vaults. Inverse relationship between MRR and money multiplier. The higher the MRR, the lower the money multiplier meaning lower amount of money created.

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11
Q

Minimum lending rate

A

Interest rate charged by central bank on loans to commercial banks. MLR influences all interest rates on bank loans

Expansionary: Central bank lowers MLR hence AD increases

Contractionary: Central bank raise MLR, AD decreases

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12
Q

Quantitative easing

A

Central bank injects money directly into the economy through purchasing corporate bonds. Bonds are type of debt, banks selling bonds to government will receive additional money which increases liquidity. Thus money supply increases -> encouraging lending -> Economic growth

Buys corporate bonds -> Money supply increased, interest rate decreased -> More borrowing -> Consumption and investment increased -> Exchange rate falls -> Export revenue increases, import expenditure decreases -> Increased in AD

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13
Q

Expansionary monetary policy

A

Aims to increase level of AD by increasing money supply and reducing interest rates

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14
Q

Contractionary monetary policy

A

Aims to decrease level of AD by decreasing money supply and increasing interest rates

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15
Q

Constraints of monetary policy - Low consumer and business confidence

A
  • Low consumer and business confidence: Even if interest rates zero, lack of confidence can lead to prolonged recession. Changes to interest can destabilise firms and consumers. In times of recession, consumers and firms unwilling to buy and borrow even if interest rates low
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16
Q

Constraints of monetary policy - Trade offs with inflation

A

Trade off with cost push inflation leading to increase in price levels and inflationary pressure.

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17
Q

Constraints of monetary policy: Economic growth and low unemployment

A

To maintain low and stable inflation rate, Contractionary monetary policy used but tradeoff with economic growth and unemployment as real GDP decreases resulting in deflationary pressures.

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18
Q

Strengths of monetary policy

A

Incremental: Can be adjusted incrementally to reduce risks of causing disruptions in economy

Flexible: Central bank independent from political interference, flexibility to act in best interest of economy

Reversible: Decision is reversible. Eg: If money multiplier underestimated and causes inflation, central bank can increase interstate rates

Short time lag: Can be implemented quicker than fiscal policy

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19
Q

Fiscal policy

A

Use of government spending and taxation to fulfil macro economics by influencing AD

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20
Q

Government expenditure

A

Money spent by government through government spending or transfer payments (Welfare payments / donations):

Current expenditures:
- Wages/Suppliers for public
- Interstate rate for national debt
- Provision of subsidies and grants

Capital expenditure:
- Infastucture

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21
Q

Government expenditure

A

Money spent by government through government spending or transfer payments (Welfare payments / donations):

Current expenditures:
- Wages/Suppliers for public
- Interstate rate for national debt
- Provision of subsidies and grants

Capital expenditure:
- Infastucture

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22
Q

Fiscal policy objectives

A
  • Low unemployment
  • Stable economic environment for long term growth
  • Low and stable inflation
  • Reducing business cycle fluctuations
  • Achieving equitable distribution of income
  • Trade balance
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23
Q

Fiscal policy objectives

A
  • Low unemployment
  • Stable economic environment for long term growth
  • Low and stable inflation
  • Reducing business cycle fluctuations
  • Achieving equitable distribution of income
  • Trade balance
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24
Q

Expansionary fiscal policy

A

AD increased by increasing government expenditure or decreasing direct / indirect taxation.

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25
Q

Government spending

A

Will improve quantity or quality of resources improving AD and AS:
- Spending on physical capital goods and R&D, improving technology
- Human capital development through training and education
- Provision of incentives for firms to invest through lower business taxes

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26
Q

Contractionary fiscal policy

A

Aims to reduce AD by decreasing government expenditure or increasing direct / indirect taxation. Can slow economic growth to prevent overheating as high levels of economic growth can cause high levels of inflation and shortages in labour market

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27
Q

Keynesian multiplier

A

Increase in value of injections into circular flow of economy results in proportionally larger increase in AD

28
Q

Keynesian multiplier formula

A

MPT + MPS + MPC + MPM = 1

Change in GDP = Change in injection * 1 / 1 -MPC

29
Q

Fiscal policy strength - Targeting specific sectors

A

Can correct regional disparities in income and spending habits, EG:
- Tax cuts to low income households while marginal tax rates increased for high income households to redistribute income

30
Q

Strength of fiscal policy - Stimulate recovery from deep recession

A
  • Provides direct injection into circular flow of income, change in national output greater than initial injection due to Keynesian multiplier.
  • Can increase confidence levels during recession, increasing AD while providing incentives for firms to continue employing workers to avoid further unemployment
31
Q

Fiscal policy limitation - political pressure

A

Political constraints and pressure mean government spending decisions influenced by political rather than economic factors. Can prevent Contractionary fiscal policy as this may be politically unfavourable

32
Q

Fiscal policy limitation - political pressure

A

Political constraints and pressure mean government spending decisions influenced by political rather than economic factors. Can prevent Contractionary fiscal policy as this may be politically unfavourable

33
Q

Fiscal policy limitations - time lag

A

Recognition lag: Takes time to tell whether economy is in need for government intervention. Can be difficult to plan for shocks like natural disasters

Administrative lag: Takes time to implement policy as approval for tax changes or changes to government budget needed

Effectiveness lag: Time lag between implementation or fiscal policies to see actual effects take place

34
Q

Fiscal policy limitations - Sustainable debt

A

Effectiveness of fiscal policy will depend on extent to which government can afford to sustain budget deficit.

In short run, governments may be able to run budget deficits. However not sustainable in long run and may need to implement austerity measures to repay national debt, limiting effectinvess

35
Q

Fiscal policy limitations - Sustainable debt

A

Effectiveness of fiscal policy will depend on extent to which government can afford to sustain budget deficit.

In short run, governments may be able to run budget deficits. However not sustainable in long run and may need to implement austerity measures to repay national debt, limiting effectinvess

36
Q

Fiscal policy limitations - Crowding out

A

In budget deficit, government needs to borrow funds. Occurs when increased government borrowing causes interest rates to rise, causes reduction in private sector investment expenditure due to higher cost of borrowing. Operation of public sector businesses can drive down private sector investment in these industries

37
Q

Fiscal policy limitations - Crowding out

A

In budget deficit, government needs to borrow funds. Occurs when increased government borrowing causes interest rates to rise, causes reduction in private sector investment expenditure due to higher cost of borrowing. Operation of public sector businesses can drive down private sector investment in these industries

38
Q

Supply side Policies

A

Aims to increase aggregate supply and productive capacity of an economy by improving quality or quantity of factors of production.

39
Q

Goals of Supply side policies

A

I - International competitiveness (reduced inflation)
C - Competition and effeciency to encourage competition
L - Labour market flexibility to reduce labour costs and unemployment
I - Incentives like cuts in personal income tax, business tax, capital gains tax
P -Productive capacity

40
Q

Market based supply side policies

A

Geared towards free market economy and promotes competition between firms, improves efficiency and potential output

41
Q

Deregulation

A

Reduction or elimination of regulations to lower costs of production for firms which encourages competition. Consumers may benefit as variety of choices to choose from and firms likely improve quality of products or lower prices

42
Q

Privatisation

A

Process in which state owned enterprises transferred from public to private sector. Increases competition and effeciency as firms in private sector have greater degree of competition and incentive to make profits. Thus more efficient

43
Q

Trade Liberalization

A

Elimination of international trade barriers as it encourages free trade increasing competition leading to greater efficiency. Producers specialise according to advantages and trade with one another leading to better allocation of world’s resources

44
Q

Anti monopoly regulation

A

Policies aimed at limiting the market power of dominant firms in industry as monopolies have no incentive to increase effeciency or innovate, thus can promote market competition improving effeciency

45
Q

Reducing power of labour unions

A

Reduce power of labour unions lowering costs of labour, effeciency increases, unemployment falls and market becomes more competitive

46
Q

Reducing unemployment benefits

A

May act as disincentive to find work, reducing will incentive people to look for work lowering unemployment and increasing effeciency in labour markets

47
Q

Abolishing minimum wage

A

Wage ridgites make it difficult for firms to lower wages thus lays off workers instead, leading to higher unemployment. By abolishing, price of labour falls and quantity of labour rises resulting in lower rate of unemployment and higher level of national output.

48
Q

Personal income tax costs

A

Reducing will increase level of after tax income disposable improving productivity incentivising individuals to do more hours or retire later. Incentive those without work thus reducing unemployment, thus increases LRAS and productive capacity of economy

49
Q

Business tax cuts

A

Reducing will increase level of after tax profits incentivizing producers to reinvest in business, results in greater capital accumulation and productive capacity leading go increased potential output

50
Q

Capital gains tax cut

A

Levied on profits earned from sales of assets like stock. Reducing will incentive firms to invest more, increases amount of capital goods in economy increasing LRAS and potential output

51
Q

Capital gains tax cut

A

Levied on profits earned from sales of assets like stock. Reducing will incentive firms to invest more, increases amount of capital goods in economy increasing LRAS and potential output

52
Q

Education and training

A

Improves quality of human capital, education and training leads to labour force becoming more skilled, efficient and productive. Increase productive capacity as LRAS shifts outward.

53
Q

Research and development

A

Business activities to introduce and innovate new products. Can improve quality or quantity of capital resources, increasing productive capacity and shifting LRAS outwards

54
Q

Provision of infrastructure

A

Refers to physical capital such as transportation systems. Investment may lower costs, improve effeciency and productivity increasing productive capacity of economy and shifting LRAS

55
Q

Industrial policies

A

Government policies which target specific industries to promote growth in key areas of economy.
- Tax cuts
- Tax allowances
- Subsidized lending
- Trade protectionist policies

56
Q

Constraints of market based supply side policies - equity issues

A

Negative effects on equity. EG: labour market reforms hurt low income earners or those relying on unemployment benefits. High income earners likely to benefit from tax reductions

57
Q

Constraints of market based supply side policies - time lags

A

Long time to get effect as they must go through drafting, presenting, voting and signing before implemented

58
Q

Constraints on market based supply side policies - vested interest

A

Individuals or groups with personal interest in certain policies or decisions

59
Q

Constraints on market based supply side policies - Enviornmental impact

A

May have detrimental effects on the environment

60
Q

Constraints on interventionist supply side policies - costs

A

Can be extremely costly for government and may lead to budget deficit. Also opportunity cost incurred when improving supply side of economy

61
Q

Constraints on interventionist supply side policies - time lags

A

Long time to take effect. EG: investment on education may take decades to affect potential output

62
Q

Strengths of market based supply side policies - improved resource allocation

A

Improve allocation of resources by improving allocative and productive effeciency. EG: competition will pressure firms to lower costs and improve effeciency

63
Q

Strengths market based supply side policies - no burden on government budget

A

Aimed at increasing free market effeciency thus no explicit costs on government. Mainly involves removal of existing government policies and encourages free market effeciency

64
Q

Strengths interventionsts supply side policies - direct support of sectors important for growth

A

Can support specific sectors deemed important for growth. EG: may provide merit goods to specific traget sectors like healthcare.

65
Q

Effectiveness of supply side policies

A

In short run supply side policies can increase AD but in long run, can increase productive capacity shown by LRAS shifting where potential output increases leading to economic growth. Can also enable economies to grow while achieving low and stable inflation.

Economy HL (6 decks)

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