PRINCIPLES OF MACRO: The Macroeconomic Environment

Question 1

15.1
What are the major macroeconomic issues?

Answer 1

Economic growth, unemployment, inflation, economic relationships with the rest of the world, the financial well-being of individuals, businesses and government and the relationship between the financial system and the economy.

Question 2

15.1
What is the term economic growth?

Answer 2

Economic growth is the term economists use to describe the change in the level of an economy’s output from period to period.

Question 3

15.1
How often is the rate of economic growth measured?

Answer 3

The rate of economic growth measures the percentage change in output. This is usually measured over short periods, such as 12 or 3 months.

Question 4

15.1
What is one of the most important observations to make about economic growth?

Answer 4

How growth is volatile

Question 5

15.1
What do fluctuating activity levels in growth imply for the economy?

Answer 5

Fluctuating activity levels are likely to affect the behaviour and well-being of many of us.

Question 6

15.1
How would fluctuating levels wellbeing and behaviour (give an example).

Answer 6

In 2009, for example, the UK economy shrank by 4.5 per cent, unemployment levels rose from 1.6 million during 2007 to 2.7 million by 2011 and the government experienced a 4.5 per cent fall in its receipts between tax years 2007/8 and 2009/10

Question 7

15.1
What is the significance of volatility in growth?

Answer 7

It is the volatility of growth that gives rise to the well-known phenomenon of the Business Cycle.

Question 8

15.1
What is the Business Cycle?

Answer 8

The periodic fluctuations of national output. Periods of rapid growth are followed by periods of low growth or even decline in national output.

Question 9

15.1
Explaining volatility: What’s an example of rising or falling output in terms of government spending?

Answer 9

For example, a rise in government spending, a reduction in taxes or a reduction in interest rates may stimulate the economy and raise the rate of economic growth.

Question 10

15.1
Explaining volatility: How else can fluctuation in economic growth be explained by the market system (demand)?

Answer 10

Some economists see the problem as rooted in fluctuations in aggregate demand: in other words, in the total demand for the economy’s goods and services, whether by individuals or firms. What is more, changes in the demands of individuals and firms may interact with each other, affecting the character of the business cycle.

Question 11

15.1
Explaining volatility: How else can fluctuation in economic growth be explained by the market system (supply)?

Answer 11

Other economists see the problem as rooted in fluctuations in aggregate supply: in other words, in the total amount of goods and services firms plan to supply at a given level of prices. These economists argue that changes in aggregate supply occur if the price, availability or effectiveness of the inputs in firms’ production processes are in some way affected.

Question 12

15.1
Explaining volatility: If people believe that the economy’s output level is about to fall, how may their actions aggravate the problem?

Answer 12

It’s most likely aggregate demand will fall since risk of the fall in the price of individual asset in turn reduces the value of things such as housing or property. This creates a negative wealth effect which incentivises consumers to cut spending due to these uncertain conditions.

Question 13

15.1
What do most economies experience over the long-term?

Answer 13

Positive long-term economic growth

Question 14

15.1
What does analysing long-run growth involve?

Answer 14

An understanding of a country’s capacity to produce. This is because, for growth to be sustained over the longer term, the economy’s capacity must increase.

Question 15

15.1
What does analysing short-run growth involve?

Answer 15

An understanding over the determinants of the business cycle and the cycle itself.

Question 16

15.1
What is the term unemployment?

Answer 16

Unemployment is defined as a situation where someone of working age is not able to get a job but would like to be in full-time employment.

Question 17

15.1
What do higher levels of economic activity imply in terms of employment?

Answer 17

Higher levels of economic activity will tend to decrease unemployment numbers, while reduced economic activity will tend to increase them.

Question 18

15.1
What are significant impacts on modern day economies from economic events (in terms of unemployment)?

Answer 18

Many countries have seen significant effects on the labour market of rapid industrial change, technological advance and globalisation.

Question 19

15.1
Why do labour markets need to act dynamic?

Answer 19

Labour markets need to be able to adapt to the dynamic environment in which they operate, not only for the sake of those who are made unemployed, but also because it represents a waste of human resources and because unemployment benefits are a drain on government revenues.

Question 20

15.1
How would you calculate an economy’s unemployment rate? Give an example?

Answer 20

If 30 million people were employed and 1.5 million people were unemployed, the unemployment rate would be.

1.5/(30+1.5) x 100 = 4.76%

Question 21

15.1
Why is it sensible to compare rates of unemployment between countries

Answer 21

When comparing unemployment across countries it is sensible to compare rates of unemployment. Total employment definitely grows per year since it is linked to the growth of a population. However, if rates of employment remain constant, this does not indicate the economy’s resources being maximised to it’s potential output.

Question 22

15.1
What is meant by the term inflation?

Answer 22

By inflation we mean a general rise in prices throughout the economy. Government policy here is to keep inflation both low and stable. One of the most important reasons for this is that it will aid the process of economic decision making. For example, businesses will be able to set prices and wage rates, and make investment decisions with far more confidence.

Question 23

15.1
Why does government seek to keep inflation low and stable?

Answer 23

Government policy here is to keep inflation both low and stable. One of the most important reasons for this is that it will aid the process of economic decision making. For example, businesses will be able to set prices and wage rates, and make investment decisions with far more confidence.

Question 24

15.1
What is meant by the rate of inflation?

Answer 24

The rate of inflation measures the annual percentage change in the general price level.

Question 25

15.1
What does the UK government post each month as a measure of inflation?

Answer 25

UK government publishes a consumer prices index (CPI) each month, and the rate of inflation is the percentage increase in that index over the previous 12 months.

Question 26

15.1
What is the inflation rate economies try to maintain?

Answer 26

Inflation at 2% because it is the rate of inflation associated with economic growth.

Question 27

15.1
What’s one way of measuring an economic relationship between economies?

Answer 27

The balance of payments account. This records all transactions between the residents of that country and the rest of the world. These transactions enter as either debit items or credit items.

Question 28

15.1
What are debits?

Answer 28

The debit items include all payments to other countries: these include the country’s purchases of imports, the investments it makes abroad and the interest and dividends paid to people abroad who have invested in the country.

Question 29

15.1
What are credits?

Answer 29

The credit items include all receipts from other countries: these include the sales of exports, inflows of investment into the country and earnings of interest and dividends from abroad.

Question 30

15.1
Explain what is the simple exchange between both the sale of exports and the purchase of imports?

Answer 30

The sale of exports and any other receipts earn foreign currency. The purchase of imports or any other payments abroad requires foreign currency.

Question 31

15.1
What happens when a country spends too much on foreign currency than it earns?

Answer 31

If a country starts to spend more foreign currency than it earns, then its balance of payments will go into deficit. If the government does nothing to correct the balance of payments deficit, the exchange rate of the country’s currency must fall.

Question 32

15.1
What is an exchange rate?

Answer 32

The exchange rate is at which one national currency exchanges for another. The rate is expressed as the amount of one currency that is necessary to purchase one unit of another currency (e.g. £1.20 = £1).

Question 33

15.1
What happens when there is a falling exchange rate?

Answer 33

A falling exchange rate (e.g. from $1.40 to $1.20) is a problem because it pushes up the price of imports and so reduces people’s purchasing power and can fuel inflation. This was the situation facing the UK in the aftermath of the vote to leave the European Union, when the pound fell sharply.

Question 34

15.1
What is an immediate example of financialisaton?

Answer 34

The most immediate evidence of financialisation is the extent to which many of us interact with financial institutions and our use of financial instruments.

Question 35

15.1
Why is it important for economies to maintain a stable financial system?

Answer 35

It is important for policy makers to ensure the stability of the financial system and the general financial well-being of economic agents. This importance was most starkly demonstrated by the events surrounding the financial crisis of 2007–9, when many banks looked as if they might become bankrupt.

Question 36

15.1
What do government macroeconomic policy tend to revolve around?

Answer 36

• High and stable economic growth.
• Low unemployment.
• Low inflation.
• The avoidance of balance of payments deficits and excessive exchange rate fluctuations.
• A stable financial system and the avoidance of excessively financially distressed sectors of the economy, including government itself.

Question 37

15.1
What are the main issues of government macroeconomic policy?

Answer 37

Unfortunately, these policy objectives may conflict. For example, a policy designed to accelerate the rate of economic growth may result in a higher rate of inflation, a balance of payments deficit and excessive lending. Governments are thus often faced with awkward policy choices.

Question 38

15.1
The volatility of short-term economic growth gives rise to what?

Answer 38

The business cycle

Question 39

15.1
What happens when an economy spends more foreign currency than it earns?

Answer 39

The balance of payments will go into a deficit and the exchange rate will fall.