Paper 1 and 2 (Key terms for both papers)

Question 1

The economic cycle

Answer 1

Boom, slowdown, recession, recovery i.e. economic growth varies according to many factors.

Question 2

Circular flow of income

Answer 2

The notion that money moves between three agents in the economy – households, firms and the government. Is shown diagrammatically. Could also be adapted to include banks.

Question 3

Injection

Answer 3

Extra money arriving into the circular flow from ‘outside’ e.g. exports or government borrowing.

Question 4

Leakage

Answer 4

Money leaving the circular flow by ‘natural’ means e.g. imports (including outward FDI) or saving.

Question 5

Withdrawal

Answer 5

Money leaving the circular flow ‘by design’ e.g. the government taxing firms and individuals (meaning they can’t spend that income). The government injects most (if not all or even more) of what it withdraws, of course.

Question 6

Aggregate demand

Answer 6

How willing and able the agents in the country are to demand goods and services at a given price levels. Is shown by Consumption + Investment + Government Spending + (Exports – Imports).
NB: day to day government spending (e.g. running the public sector) goes in G. Investment on public infrastructure projects goes in I.

Question 7

Aggregate supply

Answer 7

How willing and able firms are to supply goods and services at given price levels. Can be in the short term (SRAS), where there is no change to the total capacity of an economy e.g. a change in labour or raw material costs or in the long term (LRAS), where there is a change to total capacity e.g. quality new immigration to the labour force, increase in productivity, increase in quality or quantity of infrastructure.

Question 8

Macroeconomic objectives

Answer 8

BUDGIE (Each component has its own card)

Question 9

Balance of Payments

Answer 9

The difference between outflows of money from imports and inflows of money from exports. A BoP surplus is where value of exports is > value of imports. A deficit is vice-versa. Remember that there are two accounts within BoP – capital and current.

Question 10

Unemployment

Answer 10

People out of work who are actively seeking work. Unemployment rate = (unemployed / labour force) * 100 (where labour force = employed and unemployed people i.e. NOT population). **participation rate = (labour force / population) * 100. Calculated using either claimant count or labour force survey. People are unemployed for various reasons: structural (technological), immobility, cyclical/demand deficient, seasonal, frictional.
NB: underemployment is when a person has a job that is part time but would prefer to have more hours or be fulltime.

Question 11

(Government) debt

Answer 11

The cumulative amount of money the government has borrowed over time minus any money it has repaid. Debt is rarely repaid but instead governments attempt to make it smaller by growing the economy faster than the debt so it looks smaller as a %age of GDP.

Question 12

(Government budget) deficit

Answer 12

The difference between government income (mainly from taxes) and government spending. Where spending > income there is a budget deficit and this adds money to the total debt (see above). Again is best shown as a %age of GDP for ease of international comparison.

Question 13

(Economic) growth

Answer 13

Where there is an increase in real GDP (economic output) for two consecutive quarters (see economic cycle). Short run economic growth is caused by increasing AD. Long run growth is caused by increasing LRAS.

Question 14

Inflation

Answer 14

An increase in the general price level, measured by either RPI or CPI (both with their respective weighted basket of goods). Disinflation is where there is still inflation but it is at a slower rate than below. Deflation is where prices are falling. Cost push inflation is when a shift left in SRAS (or in LRAS in exceptional circumstances) has caused prices to rise. Demand pull inflation is where a shift right in AD has caused the price level to rise. Inflation is less likely where there is an output gap (a large space between current equilibrium and the total size of the economy). Where inflation is taken into account numbers are expressed as Real e.g. Real GDP. Without taking into account inflation is known as nominal.

Question 15

Equality

Answer 15

Inequality of income (and wealth, which is different and is ownership of assets, not constant income) has negative impacts on the economy and society. Is measured using the Gini coefficient and/or the Lorenz curve, which highlights the income/wealth of quintiles/deciles, which are the population divided into fifths or tenths according to how much income/wealth they have.

Question 16

Fiscal policy

Answer 16

Changing tax and/or government spending to achieve macro-economic objectives. Expansionary – trying to increase AD. Contractionary – trying to reduce AD (or at least stop it growing as quickly).

Question 17

Taxes

Answer 17

Can be direct (on income or profit e.g. income tax and corporation tax) or indirect (on consumption e.g. VAT, petrol etc). Income taxes are normally be progressive (richer people pay more tax as a percentage of their income and are therefore good at redistributing income) but indirect taxes are regressive (poorer people end up paying more tax on petrol as a percentage of their income than richer people). Links to circular flow of income.

Question 18

Transfer payments

Answer 18

Money given by the government to households e.g. pensions, job seekers allowance, tax credits, disability allowance etc. Links to circular flow of income.

Question 19

Subsidies

Answer 19

Money given by the government to firms to support their activities. Links to circular flow of income.

Question 20

Monetary policy

Answer 20

Changing interest rates or the money supply to achieve macroeconomic objectives. Is the responsibility of the Central Bank in most economies. This is because they are given the responsibility of meeting the inflation target (2% in UK +/-1%). Tight/contractionary/hawkish monetary policy is designed to reduce AD (or at least stop it from increasing too quickly) to keep price level growth under control. Loose/expansionary/doveish policy is designed to increase AD in order to ensure the economy doesn’t suffer deflation.

Question 21

Interest rate

Answer 21

The price of money. The cost of borrowing and the reward for saving.

Question 22

Quantitative easing

Answer 22

The process of the Central Bank increasing its own bank balance so that it can buy government bonds off financial institutions that have previously bought them. This increase in demand for these bonds, reducing their yields. The financial institutions now have extra cash (and less incentive to buy other assets as yields have fallen) so are able to lend (i.e. ending the credit crunch).

Question 23

Supply side policy

Answer 23

Anything that is designed to increase the LRAS of the economy e.g. privatisation (more efficient), new roads, public transport, broadband, investing in education/training (i.e. productivity of the work force), regulation (to encourage new firms to join markets), making labour markets more flexible e.g. reducing power of unions (to increase size of the labour force), reducing protectionism (this could be described as SRAS tbf). NB: some fiscal policies have supply side impacts e.g. reducing transfer payments could be to reduce the size of the deficit. It depends on the intention of the policy as to how to class it.

Question 24

Multiplier effect

Answer 24

Any policy could have a bigger total impact on GDP than the initial investment. This is because every £1 injected goes round the flow more than once. It will be subject to leakages each time, however.

Question 25

Conflicting policy objectives

Answer 25

The fact that it is very difficult to simultaneously achieve all six objectives. Most obvious is that increasing growth does also reduce unemployment but is likely to come with inflation and perhaps worsening inequality.

Question 26

Austerity

Answer 26

The name given to fiscal policy in the UK for the last decade. Tax increases and cuts to government spending in order to reduce the budget deficit post the global financial crisis.