Revision for Feb Mocks Paper 2 Flashcards
What is economic growth
The rate of change of output, an increase in the long term productive potential of the country.
How is GDP measured?
Percentage change in real GDP per annum.
Gross National Income
The value of goods and services produced by a country over a period of time plus net overseas interest payments and dividends.
Gross National Product
The value of goods and services over a period of time through labour or property supplied by citizens of a country both domestically (GDP) and overseas.
What is Purchasing Power Parity?
It compares how much a typical basket of goods in the country costs compared to one in another country.
It’s helpful to compare living standards, as it takes into account the cost of living.
Problems of using GDP to compare standard of living - Inaccuracy of data in detail (6)
Some countries are inefficient at collecting or calculating data.
Black market - people work without declaring their income to avoid tax/claim benefits, GDP is underestimated.
GDP does not take into account home-produced services - many poorer countries produce and consume their own crops with no trade.
Errors in calculating the inflation rate.
Methods used to calculate GDP can change.
Transfer payments need to be taken away (when money is paid to a person without any corresponding increase in output in the economy), like when govt taxes the employed and then gives it straight to the unemployed.
Name 5 problems of using GDP to compare standard of living
Inaccuracy of data
Inequalities (growth in GDP may just be due to growth in income of just one group of people)
Quality of goods and services (improved technology decreases prices, but doesn’t mean worse living standards)
Comparing different currencies - should use PPP?
Spending (some types of expenditure like defence doesn’t increase standard of living, but GDP)
What are the six key factors in the UN happiness report?
Real GDP per capita
Health
Life expectancy
Having someone to count on
Perceived freedom to make life choices/freedom from corruption
Generosity
What is the Easterlin Paradox?
An increase in consumption of material goods will increase happiness if basic needs aren’t met.
Once these needs are met, an increase in consumption won’t increase long term happiness.
Other than the Easterlin Paradox, why else would happiness be subjective and not entirely dependent on income?
Income and happiness depends on the people around us, social status.
If you’re the riches out of everyone you associate with, you’ll be much happier than someone who has the same exact same income but is the poorest out of everyone they associate with.
Govevernment 4 main macroeconomic objectives
Low unemployment
Low and stable inflation
Economic growth at a similar rate to other economies
Balance of payment equilibrium
4 reasons why the AD curve is downward sloping
Income effect (inflation means people at first have lower real incomes, so can buy less, lower demand)
Substitution effect (inflation means less foreigners want to buy exports and more residents buy imports, AD contracts)
Real balance effect (inflation, savings not worth as much, less security, want to save more and reduce spending, AD contracts)
Interest rate effect (inflation, firms pay workers more, higher demand for money, higher interest rates, more people will save, businesses invest less, AD contracts)
Consumption
Spending on consumer goods and services over a period of time.
What is MPC?
Change in consumption/change in income
The proportion of an increase in income spent on consumption
What is APC (average propensity to consume)?
Total consumption/total income
The average amount spend on consumption out of total income.
Influences on consumer spending (6)
Income
Interest rates
Consumer confidence
Wealth effects
Distribution of income
Tastes and attitudes
What is the wealth effect?
People with greater wealth tend to have greater levels of consumption.
Improved productive efficiency due to better technology could lead to lower prices or higher quality goods.
Some argue that increase economic growth will lead to increased happiness.
Economic growth could lead to increased inequalities, many not have any effect on the average consumer, may lead to inflation, may have negative effects for consumers.
What is investment?
The addition of capital stock to the economy.
What is gross investment?
The amount of investment carried out and ignores the level of depreciation.
Net investment
Gross investment minus the value of depreciation.
Influences on investment (9)
Rate of economic growth (partly dependent on demand)
Business expectations/confidence - ‘Animal spirits’ (confidence about the future increases investment)
Demand for exports
Influence of govt and regulations (govts could offer tax breaks or grants to businesses to try and encourage them to invest)
Access to credit (investment lower when an investment has a high risk attached to it, so less access to credit) or interest rates
Retained profit
Technological change
Costs
Influences on govt expenditure (3)
The trade cycle (in recession, the govt may increase spending to increase demand to reduce unemployment)
Fiscal policy
Age distribution of the population (older means increase govt spending on pensions, social care, younger means education spending)
Influences on net trade balance (6)
Real income (more imports)
Exchange rates
State of world economy (incomes of export country considered)
Degree of protectionism (tariff, quotas, technical barriers to help domestic production)
Non-price factors (quality, design/marketing)
Prices
Why is the AS curve upwards sloping?
In the short run, if a business wants to increase production they need to increase the hours of work their employees do.
Firms may decide to take on temporary workers or get present workers to work overtime or work harder, offering incentives like bonuses.
Though basic wage rates have stayed the same, average/marginal cost of labour per good produced will rise.
This is then passed onto the consumer in increase prices.
Why is short run AS likely to be elastic?
An increase in output by firms is likely to increase in costs which leads to a rise in prices as they pass these costs onto consumers.
However, because the factor prices are constant, the increase in prices will be relatively small.
Factors influencing SRAS (3)
Changes in costs of raw materials and energy
Changes in exchange rates (weaker pound leads to increase in the price of imports, SRAS decreases as production becomes more expensive)
Changes in tax rates
Classical LRAS
Classical believes AS is independent of the price level and is determined by the level of all factors of production and quality of technology.
In the short run it’s possible for an economy to exceed the maximum potential LRAS by allowing factors of production to work overtime or not allow time for maintenance of machinery.
However, it’s not possinle in the long run - machines eventually stop and workers will want a break.
The AS curve is vertical, based on the view markets tend to correct themselves fairly quickly.
Keynesian LRAS
Wages tend to be ‘sticky downwards’, not falling below a certain level because of unions, motivation and minimum wage.
When there is high unemployment, low wages, perfectly elastic LRAS. At low unemployent, it’s more inelastic.
Factors influencing LRAS (6)
Technological advantages
Changes in relative productivity
Changes in education and skills
Changes in govt regulations (changing size of workforce, R&D tax break incentives, entrepreuneral grants)
Demographic changes and migration (immigration increase dependent on skills, age of population)
Competition policy
What goes from households to firms in the circular flow of income?
Consumer spending
Factors of production
What goes from firms to households in the circular flow of income?
Wages, rents, dividends
Goods and services
Injections to the circular flow of income
Exports
Govt Spending
Investment
Withdrawals from the circular flow of income
Savings
Taxation
Imports
Why is the firm + house circular flow of income model too simple?
Govt needs to be added, as they tax and spend, and affect the flow of income.
Introduce financial services who can inject with investment, and withdraw when consumers/producers save.
Foreign markets need to be added, they inject by buying exports and sell, increasing and decreasing the circular flow of income respectively.
What is a positive output gap?
When GDP is higher than predicted; the economy is producing above full output
What is the multiplier?
An increase in an injection will lead to an even greater increase of national income.
1/1-MPC
1/MPW
What is the accelerator effect?
When an increase in national income (GDP) results in a proportionately larger rise in capital investment spending.
What is the multiplier process?
It’s the idea that an increase in AD because of an increased injection can lead to a further increase in national income.
Effects of the multiplier on the economy (4)
The multiplier means that growth can occur quicker, as any injections lead to a bigger increase in national income. Injections can be targeted at those with the biggest MPC in order to increase the size of the multiplier.
However, it’s impossible for the govt to know the exact effect of their spending as it is difficult to know the size of the multiplier.
There will also be a time lag between the increase in income and the full effect of that increase - not everyone will spend straight away.
The overally effect depends on the change in AD and the elasticity of the AS curve.
How do you calculate Marginal Propensity to Withdraw?
Marginal Propensity to save
+
Marginal Propensity to tax
+
Marginal Propensity to import
How does the multiplier affect AD?
The multiplier increases AD, but to have the desired effect, there myst be sufficient spare capacity in the economy for extra output to be produced.
If the classical LRAS is perfectly inelastic, then the multiplier is just inflationary. The more elastic the SRAS curve is, the smaller the effect on price but the bigger the effect on output.
Therefore, the effect of the multiplier depends on the shape of the AS curve and whether it is short run or long run. The size of the increase in AD will depend on both the size of the initial increase in AD and the size of the multiplier.
Actual growth vs potential growth
Actual growth is the percentage change in GDP.
Potential growth is the change in the productive potential of the economy over time.
What is the long run trend rate of growth?
The average sustainable rate of economic growth over a period of time.
Name the order of trade cycle
Boom
Recession
Slump
Recovery
Why does the trade cycle exist
Demand and supply side shocks.
Demand side shocks could be the collapse of a housing bubble, political issues, changes in exchange rates or a recession in the world economy.
Supply side shocks could include trade union action, a change in oil prices or a chnage in the exchange rate.
What is expansionary policy?
Aimed at increasing AD to bring about growth.
What is deflationary policy?
Attempts to decrease AD to control inflation.
What is monetary policy?
Where the central bank or regulatory authority attempts to control the level of AD by altering base interest rates or the amount of money in the economy.
What is fiscal policy?
The use of borrowing, govt spending and taxation to manipulate the level of aggregate demand and improve macroeconomic performance.
Explain interest rates as a form of monetary policy (how it affects different components of AD)
Monetary policy committee are able to change the official based rate in order to tackle inflation.
A rise in interest rates cause a fall in AD through four key mechanisms:
Increases the cost of borrowing, more saving, fall in demand for stocks/shares/govt bonds, fall in investment, consumption, AD.
Fall in prices for assets, negative wealth effect, fall in consumption. AD falls because of fall in consumption and investment.
Interest rates rise = less consumer/business confidence. Loans become more expensive.
Increases the incentive for foreigners to hold their money in British banks, higher rate of return. Value of pound rises, decreases net trade, AD.
Problems with using interest rates as monetary policy (6)
The exchange rate may be affected so much that exports fall significantly, imports rise, causing trade deficit.
Changes in interest rates take up to 2 years to have their fall effect - small changes in interest rates may not affect people’s decisions.
Sometimes, interest rates are so low that they cannot be decreased any further to stimulate demand.
Not every interest rate is affected by the BoE base rate.
A lack of confidence in the economy may mean that now matter how low interest rates are, consumers and businesses do not want to borrow or banks do not want to lend to them.
High interest rates over a long period of time will discourage investment and decrease LRAS.
Explain quantitative easing
The BoE buys assets in exchange for money in order to increase money supply and get money moving around the economy during times of very low demand.
The BoE can increase the size of banks’ accounts at the BoE (reserves), which encourages them to lend money.
The BoE could also buy securities or bonds from private sector institutions such as insurance companies, pension funds and banks.
Prevents the liquidity trap, where even low interest rates cannot stimulate AD.
How does quantitative easing increase AD?
Since the bank is buying assets, there is a rise in demand, and so asset prices rise.
Positive wealth effect, more consumption, cost of borrowing decreases (as higher asset prices mean lower yields).
Money supply increases, private sector companies receive more money which they can spend on goods and services or other financial assets, which may increase investment or consumption, increase AD. Banks, more reserves, increase lending, AD up.
Commercial banks lower their interest rates because of their money from the BoE so can offer very low interest deals to their customers. AD increase.
Problems with quantitative easing (4)
It’s risky - if not controlled properly, could cause high inflation/hyperinflation.
Others say it would only increase demand for second hand goods which pushes up prices but not AD. It doesn’t lead to more new houses being built, only secondhands becoming more expensive.
No guarantee that higher asset prices lead into higher consumption through the wealth effect, especially if confidence remains low.
Had a large impact on the housing market-worsening issues of geographical mobility, also leading to rising share prices, increasing inequality, since the rich grow richer whilst the poor see none of the gains.
Name 2 forms of monetary policy
Interest rates
Quantitative easing
What is the role of the Bank of England
Their main aim is to keep inflation at 2%.
They use CPI in order to see whether this target has been met.
5 people from the BoE are in the MPC, with 4 outside experts. They adjust the bank rate.
Two main ways of increasing AD through fiscal policy.
Tax decrease
Rise in govt spending
Difference between direct and indirect taxes
Direct: Taxes paid directly to govt by individual taxpayer.
Indirect: Where the person charged with paying the money to the govt is able to pass on the cost to someone else.
Is income tax direct or indirect tax?
Direct
Problems which need to be considered when evaluating fiscal policy (4)
Govt spending impacts LRAS - could be reducing the quality of education or spending on R&D.
Political issues - tax raises are unpopular, can lead them to be voted out of govt.
Expansionary fiscal policy is difficult to undertake during a period of austerity. The govt needs to consider the effects of policies on the budget.
The impact of fiscal policy depends on the multiplier. Classical economists argue the multiplier is almost zero, Keynesian economists argue that it can be large if targeted correctly.
Classical vs Keynesian view on demand side policies
Classical economists argue that any demand management will have no effect on long-run output so supply side policies should be used. they believe increasing AD during a depression will have no effect other than to increase prices.
Keynesian economists believe the impact of changes in AD depend on where the economy is operating.
Monetary vs fiscal policy
Monetary policy is useful as the govt is able to increase demand without having to increase their spending, which would result in a larger fiscal deficit. Classicists argue that if demand management is going to be done, only monetary policy should be used.
Fiscal policy can impact the supply side of the economy - spending on education can increase LRAS. It’s more effective at targeting specific groups and reducing poverty, like through benefits.
Causes of the Great Depression
Loss of cosumer and business confidence - firms cut back investment, consumers spent less.
US banking system - the govt allowed banks to fail after the crash, banks had leant too much.
Protectionism - reducing world trade decreased AD and confidence. Firms involved in exports were no longer able to pay back their loans.
Gold standard - UK’s currency was fixed to the value of gold and other currencies. The pound appreciated rapidly and exports fell as they became more expensive.
Policy responses to Great Depression in UK
Balancing govt budget by cutting public sector wages and unemployment benefits while raising tax.
The UK left the gold standard due to continued speculation against it. Depreciation, allowing AD by exports, consumption and investment, while interest rates were cut.
Policy responses to the Great Depression in the USA
Wanted a balanced govt budget.
However…
Franklin Roosevelt was elected in 1932 with his New Deal which promised public sector investment, work schemes for the unemployed and fiscal stimulus.
Causes of the Global financial crisis
Subprime mortgage lending
Fall in confidence (banks stopped lending to each other)
Policy responses to the Global financial crisis in the UK and USA
Govts were forced to nationalise banks and building societies and guarantee savers their money in order to save banks from collapsing.
Expansionary monetary policies (record low interest rates and quantitative easing)
2 types of supply side policies
Market based policies (designed to remove anything that prevents the free market system working efficiently)
Interventionist policies (designed to correct market failure, like through govt provision, encouraging investment in private markets)
Name 5 supply-side policies
Increasing incentives (benefits, universal credit, investment incentives by decreasing taxes)
Promoting competition (privatisation, competition policy through the CMA)
Reform the labour market (retirement age, weakening trade unions, changing employment contracts, higher mobility of labour, benefits, minimum wage)
Improving skills of labour force (education and training, regulation on businesses training their staff, increase in high skilled migrants)
Improve infrastructure (tax incentives or subsidies on investment, govt spending, new technology)
Disadvantages of increasing incentives as a supply side policy (4)
Many people may argue a small change in any tax will have little impact on people’s incentive to work.
Reduction of tax on high income earners will lead to more income inequality.
Less govt revenue, opportunity costs of other spending.
Reducing benefits worsen equality.
Disadvantages of promoting competition as a supply side policy
Possible poorer quality service.
Could cause environmental issues if deregulation is seen in environmental regulations.
Disadvantages of reforming the labour market as a supply side policy
Trade unions are already weak in the UK, no point reducing their power further.
Reducing benefits will lower AD if people are unable to get job - further fall in employment. Multiplied effect, as the poor have a high MPC, AD falls by a lot.
Increased income inequality.
Making the labour force more flexible will lead to decreased quality of life as people are less secure in their jobs and may have to work odd hours. Could even decrease pay, lower AD.
Disadvantages of improving skills and quality of the labour force as a supply side policy
Improving education may have no effect if it is in skills not relevant to the workforce.
Increasing education will incur an opportunity cost, govt spending.
Increasing education will take a while for full effect.
Disadvantages of improving infastructure as a supply side policy
Offering tax breaks/subsidies lowers tax revenue.
Some businesses may not invest subsidies and may use it as a method of tax evasion.
Investment may not always be successful in improving supply as it may not achieve its aim or it may not be aimed at increasing supply.
Evaluation of supply side policies in general (8)
FOR:
Can increase output and decrease prices, unlike demand-side policies.
Long-term policies, long-term economic growth.
Can be directed at increasing exports, improving the balance of payments.
AGAINST:
No impact when LRAS is elastic (on Keynesian LRAS curve)
Not all supply side policies work at increasing supply, whilst others cause conflicts. Depends on the policy used.
The government has to spend more money, budget deficit.
Undesirable impacts on AD - could cause unemployment or higher inflation.
Supply side policies take a long time to have any effect on output.
What is globalisation?
The growing interdependence of countries and the rapid rate of change it brings about; movement towards free trade of goods and services, free movement of labour and capital and free interchange of technology and intellectual capital.
Factors contributing to globalisation
Improvements in transport infrastructure and operations have meant there are quick, reliable and cheap methods to allow production to be separated around the world.
Improvements in IT and communication allow companies to operate across the globe
Trade liberalisation and reduced protectionism has made it cheaper and more feasible to trade; this has been occurring since 1945. The breakdown of the soviet bloc and the opening of China has shown a whole area of the world for business to expand into.
International financial markets have provided the ability to raise money and move money around the world, necessary for international trade.
TNCs (large companies operating around the world) have led to globalisation by acting to increase their own profit as they want to take advantage of low labour costs. They sell and produce their goods all around the world and have the power to lobby governments.
Impacts of globalisation on consumers
More choice of goods
Lower prices (with comparative advantage and production in countries with lower costs)
Rise in prices (due to incomes rising, higher demand for goods and services)
Impact of globalisation on workers
Large scale unemployment/employment, transferring production from Western countries to countries like China and Poland.
Increased migration: may lower wages but can also provide skills and an increase in AD which increases the number of jobs
International competition has led to a fall in wages for low skilled workers in developed countries.
The wages for high skilled workers appear to be increasing, since there is more demand for their work; this is increasing inequality.
TNCs tend to provide training for workers and create new jobs.
Those working in sweatshops will see poor conditions and low wages.
Impact of globalisation on producers
Firms can source products from more countries and sell them in more countries. This reduces risk since a collapse of the market in one company will have a smaller impact on the business.
They can employ low skilled workers much cheaper in developing countries and can exploit comparative advantage and have larger markets, both of which can increase profits.
Firms who are unable to compete internationally will lose out.
Impact of globalisation on government
The govt may be able to receive higher taxes, since TNCs pay tax and so do the people they employ. However, they could lose out through tax avoidance.
TNCs also have the power to bride and lobby govts, which could lead to corruption.
If the govt uses the correct policies, they can maximise the gains and minimise the losses.
Impact of globalisation on environment
The increase in world production has led to increased demand for raw materials, which of which is bad for the environment.
Increased trade and production has also led to more emissions.
However, globalisation means the world can work together to tackle climate change and share ideas and technology.
Impact of globalisation on economic growth (3 good, 2 bad)
Increases investment with TNCs investing as an injection (will have larger impact due to multiplier). Encourages countries to make supply-side improvements to get TNCs in their country.
TNCs may bring world class management techniques and technology which can have knock on benefits to all industries as these techniques and technologies are available for them too.
Trade will increase output since it allows exploitation of comparative advantage.
However, the power of TNCs can cause political instability as they may support regimes which are unpopular and undemocratic but that benefit them or could hinder regimes which don’t support them.
Comparative cost advantages will change over time and so companies may leave the country when it no longer offers an advantage which will cause structural unemployment and reduce growth.
Compare the theory of absolute and comparative advantage
Absolute advantage exists when a country can produce a good more cheaply in absolute terms than another country.
The theory of comparative advantage states that countries find specialisation mutually advantageous if the opportunity costs of production are different. Comparative advantage exists when a country is able to produce a good more cheaply relative to other goods produced.
