The Trade Cycle Flashcards
Circular Flow Equilibrium
Economies are in equilibrium when injections equal withdrawals
The Accelerator
Investment creates a continuous stimulus for economic growth where the faster the economy grows, the faster the growth becomes.
Increased investment = increase in national income = increase in demand, starts again
Multiplier Effect
Injections into the economy increase growth by more than the value of the original injection by all the subsequent times it is re-spent
Multiplier Formula
1
K = ————
1 - MPC
K = multiplier MPC = marginal propensity to consume (% of income earned that is likely to be respent)
The Trade Cycle
Explains the sequence of growth and decline in national income in a given economy when there is no government intervention
4 Trade Cycle Periods
Boom - period of rapid growth
Recession - growth slow down then decline
Depression - growth reaches lowest point
Recovery - growth slowly increases
Boom Phase
During the phase:
- Capacity and labour are fully utilised
- Unemployment is very low
- Companies are profitable and optimistic
- Gov has a budget surplus from high tax rev
End of the phase:
- Supply can’t meet demand
- Excess demand = bottlenecks, shortages and inflation
- Imports rise due to excess demand
- Imports is a withdrawal
End of Boom Aggregate Demand
Aim for a gov is to lower AD:
- Increase taxation
- Reduce public spending
- Increase interest rates
Recession and Depression
Demand begins to fall Revenues and profits fall Investors lose confidence, investment falls Low profits increases unemployment Inflation falls Gov has a deficit from low tax rev
Boosting Aggregate Demand
Aim for gov is to increase AD:
- Lower taxation
- Increase public spending
- Reduce interest rates
Recovery Phase
Demand begins to stabilise Investors gain confidence Production and profits rise Increased profits increases employment Prices are consistent before slowly rising Govs see deficits shrinking
Aim is to boost aggregate demand
Trade Cycle Affects on Goods
Capital goods - large falls and rises in demand as investment stalls and increases
Necessities - limited affect as these will still be bought
Non-essentials - large falls in demand during downturns as consumers delay purchasing until conditions are better
Goods sold to public sector - demand may fall if gov spending is reduced, but will rise when gov spending increases
Employment
The amount of people in work. Full employment is reached when everyone who is able and willing to work is in a job
Unemployment Rate
Number unemployed
——————————- x 100
Total workforce
Why is Unemployment a Problem?
- Output is below full capacity
- Long term loss of labour
- Increased welfare costs
- Fall in tax revenue
- Potential increase in crime/unrest
- Falling national income
Types of Unemployment
Cyclical - which part of trade cycle?
Structural - changing industries in a country leading to rising unemployment
Frictional - people between jobs
Seasonal - self explanatory
Voluntary - workers choose not to work at current wage rate
Classic/real wage - wages are too high so businesses aren’t hiring
Technological - workers displaced by tech
Inflation - Purchasing Value of Money
The amount of goods which can be bought for one item of currency
RPI & CPI
Both based on the average prices of a typical basket of goods. RPI includes direct and associated costs of housing, CPI ignores housing costs
Why is Inflation a Problem?
Standards of living fall as money buys less
Investment stalls
Purchasing power of savings falls
Affects a country’s trading performance as exports will suffer
Types of Inflation
Demand-pull - high demand causes price rises
Cost-push - rising costs put prices up. Costs increase of raw materials, increased tax, etc
Wage price spiral - wage increases cause price increases
Stagflation - a recession with high inflation
Inflationary Gap
When aggregate demand exceeds aggregate supply leading to an increase in prices
