Paper 2 Flashcards
what occurs in a financial market
financial liquid assets are exchanged .g stock or bond market
role of the financial market
to facilitate saving - provide somewhere for consumers + firms to store their funds, savings are rewarded with interest rates
lend to businesses + individuals - allows consumption and investment , sometimes referred to as financial intermediary
facilitate the exchange of goods + services - by creating a payments system : cheques, paper money, credit card services, bank transaction, banks buy + sell foreign currencies
provide forward markets - firms are able to buy and sell into the future at a set price e.g. farmers selling the produce that they are growing in a month time at a guaranteed price
provide a market for equities - involves the trade of shares
impacts of a tax change
incentive to work
tax revenue
income distribution
real output and employment - effects income and therefore AD, higher indirect taxes effects SRAS, higher income taxes + disincentive to work
price level change - due to shifts in LRAS and AD
trade balance - consumers spend less on imports –> in the long run less AD decreases a business need to invest and this could reduce competitive FDI
lower corporation tax encourages firm to more production to your country –> this results in a “ race to the bottom “ = lower revenue for all countries
national debt definition
is the sum of all the government debts built up over many years
fiscal debt definition
is when government spends more than it receives in a given year
structural deficit definition
the fiscal deficit that occurs when the cyclical deficit is zero, it is not related to the state of the economy
cyclical deficit definition
is the deficit that occurs because government spending and tax fluctuate around the trade cycle
factors increasing the size of the fiscal deficit
trade cycle - during a downturn government tax revenue reduces
unforeseen events - natural disaster / recession
interest rates - IR on national debt (£82 billion)
privatisation - one off payment to the government
government aims - does the government care about the debt
factors such as number of dependants
high revenue from oils = budget surplus
factors influencing the size of national debts
if the governments is continuously running a fiscal deficit national debt will increase
ageing population = pension programs + lack of people working therefore a reduction in income tax
significance of high fiscal deficit and national debt
- high levels of borrowing may raise interest rates in the economy as it increases the demand for money therefore the price of money increases
- countries have to pay a large amount servicing their national debt through interest repayments –> high opportunity cost –> debt interest is £82 billion
- high levels of debt reduce the credit rating for the government so the UK looks like a “risky choice “ for lenders leading to higher interest rates –> realistically it is not the size of the debt that loses credit rating, it is whether the country has defaulted on payments before e.g Russia
- could cause demand pull inflation AD –> if government is unable to borrow money they will have to print their own which will cause hyperinflation, as seen in Germany in 1923
- if government borrowed from abroad it may struggle getting enough of that currency to make its repayments
- government borrowing can increase growth if it is used for capital spending since this will improve the supply side of the economy
market failure in the financial sector - speculation and market bubbles
- buy assets at low prices and sell at higher prices
–> what if deals are leveraged then prices fall
–> excessively high estimates of future price increases can create a market bubble and over paying for assets
—> eventually people realise this so demand and therefore price plummet –> people realise prices are falling + begin to sell faster further decreasing the price
^ this is an even bigger problem for the banks as they now have no money as people cannot pay back their loans
–> they also may not be able to give their costumers their money = financial crash ( liquidity crisis )
market failure in the financial sector - asymmetric information
- when the buyers are most likely those who the seller does not want to sell to due to imperfect information
- e.g health insurance
- premium is based on who they think will buy the insurance
- healthy people don’t buy it, sick people do
- only unprofitable buyers are buying, meaning the company could struggle
- premium increases only make the problem worse
market failure in the financial sector - negative externalities
- cost to the taxpayer of bank bailouts ( “ too big to fail”)
- loss of savings - of individuals in the bank
- loss of jobs, income , growth –> potential collapse of the whole economy, as a result of their overproduction and over risk taking
market failure in the financial sector - moral hazard
” too big to fail “
bankers make risky decisions knowing if they fail the burdens do not fall on them
market failure in the financial sector - market rigging
- where traders / bankers / intermediates collude to manipulate markets and make huge profits
- e.g. libour and forex markets
- heavy fines + regulation but can still occur if punishment + enforcement is weak
macroeconomic polices in a global context : reduce fiscal deficit and national debt
- government has been using a policy of austerity since 2010 where they attempt to decrease spending –> they could also increase taxes but this would be highly unpopular
- opposition parties advocate for demand stimulus by high spending which will eventually bring about higher tax revenues –> allowing for a budget surplus and then a reduction in national debt
- rely on automatic stabilisers –> shown by the US’ response to the financial crisis and their economy recovered fairly quickly –> by 2015 the fiscal deficit as a % of GDP was the same as the uk
- could default on loan
macroeconomic polices in a global context : reducing poverty and inequality
free market forces will make poverty + inequality
–> however most agree that some level of redistribution of income is necessary but the degree to which is continuous as high incomes in society provide an incentive
progressive tax –> depends on how effective government are at redistributing USA vs Finland
inheritance tax which means wealth cannot be passed on
government expenditure: universal benefits , means tested benefits
- government can provide goods and services such as school , education, healthcare meaning people are given a more + start in life
- max wage minimum wage
- equal pay legislation ( men , women , ethnicity )
- trade union friendly legislation
- employers could provide benefits to their workers : sickness pay , medical care, pensions
- price controls however thus may create a black market for the excess supply
- trickle down effect
- redistribution of income increases marginal utility
- improvement in education and training opportunities will prevent children from under privilege backgrounds achieving less than others –> e.g. lower university requirements
macroeconomic polices in a global context : changes in interest rates and the supply of money
- domestic reasons such as to control inflation –> or global issues such as exchange rate or a change in world commodity prices
- there is no simple relationship between money supply and inflation because :
CB cannot simply control the money supply because they cannot control the ability of the financial system to create credit
–> globalisation of the financial market has also made it harder to control the money supply
macroeconomic polices in a global context : international competitiveness
- supply side measures will improve productivity and flexibility, can involve taxes and deregulation
- -> encourage competition competition = innovation + competitiveness
- -> education will improve the skills of the workforce
- exchange rate policies e.g. china devalues their currency to increase exports
- join WTO or sign trade agreements
macroeconomic polices in a global context : transnational companies
- huge gains for the economy through job creation and the tax revenue they raise –> they also innovate and invest
- however negative economic and social impact by destroying local culture, affecting the environment –> withdrawing more profit than they invest –> history of influencing politicians = illegal
- some developing countries only allow this to set up if they partner with a local company > meaning some profit is retained within the country > government also use contracts to ensure some of the value is retained in the country
macroeconomic polices in a global context : transnational companies
- huge gains for the economy through job creation and the tax revenue they raise –> they also innovate and invest
- however negative economic and social impact by destroying local culture, affecting the environment –> withdrawing more profit than they invest –> history of influencing politicians = illegal
- some developing countries only allow this to set up if they partner with a local company > meaning some profit is retained within the country > government also use contracts to ensure some of the value is retained in the country
macroeconomic polices in a global context : regulation of transfer pricing
- tax avoidance
- in the uk companies which don’t make sufficient profits are challenged by HMRC
- it is difficult to control global companies so they get away with lots of tax avoidance
they use countries like Luxemburg to get away with it, every £1 Luxembourg makes in corporation tax another country loses 1000 - worldwide solution would benefits those such as the uk or USA
macroeconomic polices in a global context : problems facing policy makers
inaccurate information > trends change , government is always behind with the stats
risks + uncertainty > cannot accurately predict the future
external shocks . government aim to lessen their impacts
Reasons for restriction of free trade
Infant industries - newly established so unable to compete in global markets due to: reputation, costumer base, sunk costs, high AC and lack of economies of scale
Job protection - concern that by allowing imports domestic producers will lose out to international firms = job loss
Protection from potential dumping - excess supply being sold at extremely low prices internationally harming domestic producers > in China tariffs were placed on stainless steel tubes from the EU and Japan
Protection from unfair competition - different health and safety rules allow some firms to have much lower costs. Heavy subsidisation from governments > harms domestic producers
Dangers of over specialisation - no country should be totally reliant on another
