National and International Economy

Question 1

What are the three injections?

Answer 1

Investment
Government spending
Exports

Question 2

What are the three withdrawals?

Answer 2

Savings
Taxation
Imports

Question 3

Define marginal propensity to consume

Answer 3

The increase in consumption following an increase in income. Specifically, how much consumption increases per £ of additional income

Question 4

How do you calculate the multiplier?

Answer 4

Multiplier = 1/(1 - mpc)
Multiplier = 1 / (mps + mpt + mpm)

Question 5

How do you use the multiplier?

Answer 5

Multiplier x injection = total increase in GDP

Question 6

Define the multiplier effect

Answer 6

When an injection into the circular flow leads to a greater proportional increase in AD

Question 7

Define the accelerator effect

Answer 7

An economic postulation whereby investment expenditure increases when aggregate demand/national income increases

Question 8

Explain the accelerator effect

Answer 8

1) Increase in consumer demand
2) Firms get close to full capacity
3) Firms invest to meet rising demand and increase capacity

Question 9

Define an economic shock

Answer 9

An unexpected or unpredictable event that affects the economy

Question 10

What two ways can shocks be categorised?

Answer 10

1) demand-side or supply-side
2) positive or negative

Question 11

What are world demand shocks?

Answer 11

Shocks associated with a rise or a decline in spending and confidence abroad

Question 12

What are world supply/price shocks?

Answer 12

Shocks that affect the global supply and the price of goods and services

Question 13

Give 2 supply side shocks that have resulted from COVID-19

Answer 13

1) Fall in productivity due to disrupted economic supply chains, temporary business closures and growth in business bankruptcies
2) A fall in business investment due to a loss of confidence

Question 14

Give a demand side shock as a result of COVID-19

Answer 14

Sharp fall in consumer demand due to shop closures, leading to a rise in unemployment and a rise in redundancies

Question 15

Give 3 points of evaluation when analysing economic shocks

Answer 15

1) The size of the shock - a slowdown is not the same as a recession.
2) The scale of the shock - regional vs global
3) What are the multiplier/accelerator effects?
4) Can economic policy respond - is the response likely to be effective?

Question 16

What can demand and supply side shocks cause?

Answer 16

Cyclical instability - leading to booms and slumps in the economy

Question 17

What is another cause of cyclical instability?

Answer 17

Confidence
1) When the economy shows signs of instability, consumers and firms become risk averse
2) May lead to individuals saving a larger % of their income
3) Larger saving rate can cause a larger fall in output and thus more instability (Made worse by herding habits)

Question 18

What could exacerbate economic cyclical instability?

Answer 18

The interaction of the multiplier and the accelerator

Question 19

Define macroeconomic stability

Answer 19

The absence of excessive fluctuations in the macroeconomy, key economic indicators are in balance

Question 20

Give 3 ways macroeconomic stability can be measured

Answer 20

1) The size and volatility of inflation
2) Changes and amount in/of unemployment
3) The stability of the exchange rate in currency markets
4) Real GDP growth over one or more business cycles

Question 21

Give 2 benefits of a stable economy

Answer 21

1) Stable low inflation encourages higher investment which is a determinant of improved productivity
2) Stable inflation helps maintain price competitiveness for exporters
3) Stability breeds higher levels of consumer and business confidence - drives spending into the circular flow

Question 22

How may economic growth and environmental sustainability conflict?

Answer 22

1) Increased growth = increased AD
2) Firms produce more to meet increased AD
3) More production leads to increased pollution and increased use of land
4) Leads to polluting the planet and depleting natural resources.
5) Leads to decreased environmental sustainability

Question 23

How may economic growth and income distribution conflict?

Answer 23

1) Economic growth often creates the best opportunities for those who are highly skilled and educated
2) Worsens income inequality

Question 24

How may economic growth and a balanced, stable balance of payments conflict?

Answer 24

Increased AD = Increased Income = Increased Inflation = Decreased International Competitiveness = Increased Imports and Decreased Exports = Unbalanced BOP

Question 25

How may economic growth and full employment conflict?

Answer 25

Increased LRAS could cause a negative output gap, where the economy operates below full employment

Question 26

What does the Lorenz curve show?

Answer 26

Income distribution within an economy

Question 27

What can be calculated from a Lorenz curve, and what does it show?

Answer 27

The Gini coefficient
(Smaller Gini coefficient = more income EQUALITY)

Smaller Gini coefficient = more income EQUALITY.

Question 28

What does the quantity theory of money state?

Answer 28

That there is a direct relationship between the quantity of money in the economy and the price level

Question 29

What is Fisher’s equation, and explain what each term means?

Answer 29

MV = PT
M = money supply
V = velocity of circulation (how many times money changes hands)
P = price level
T = volume of transactions of goods and services

Question 30

What does the theory around the quantity theory of money assume?

Answer 30

That V and T are constant in the short term.
Therefore any increase in the money supply will directly lead to an increase in the price level.

Question 31

Explain the process of quantitative easing

Answer 31

1) The central bank creates money electronically
2) This money is used to purchase financial assets - mainly government bonds
3) More demand leads to increased price for assets, e.g. higher bond prices
4) Rise in bond prices leads to a lower yield on the bonds
5) This leads to reduced interest rates
6) Also, more liquidity for banks to loan causes an increase in the supply of loanable funds, also reducing interest rates
7) Lower interest rates and increased cash in the banking system should stimulate consumption and investment, hence growth

Question 32

What is a liquidity trap?

Answer 32

A term originally used by Keynes to describe a situation when even low nominal interest rates have little effect on AD because of low consumer and business confidence, and a fragile banking system

Question 33

What real life impact has quantitative easing had?

Answer 33

Estimated to have cut long term interest rates by 1% making it easier for companies to issue bonds and for people to get cheaper mortgages
Helps avoid the threat of deflation

Question 34

What does the MV part of Fisher’s equation represent?

Answer 34

Expenditure (what is bought)

Question 35

What does the PT part of Fisher’s equality represent?

Answer 35

Output (what is sold)

Question 36

Why does an increase in the money supply increase the price level?

Answer 36

More money chasing the same quantity of goods and services will put upward pressure on prices

Question 37

What is an evaluation point on the quantity theory of money?

Answer 37

Keynesian economists argue that V and T are not fixed and are not stable
Therefore there is not a direct relationship between M and P

Question 38

Define inflation

Answer 38

The sustained rise in the average price of goods and services in an economy in a given period of time

Question 39

Define disinflation

Answer 39

A fall in the inflation rate, the general price level is increasing at a slower rate

Question 40

Define deflation

Answer 40

A decrease in the general price level - a negative inflation rate

Question 41

How is inflation measured?

Answer 41

Measured by calculating the average weighted increase in the price of a typical basket of goods over a period of time

Question 42

What are the two main ways of measuring inflation?

Answer 42

1) Consumer price index
2) Retail price index (takes house prices into account)

Question 43

How is a typical basket of goods determined?

Answer 43

It is made to reflect the spending habits of individuals