theme 2 Flashcards
what is the circular flow of income?
its a model of the economy where the major exchanges are represented as flows of money, goods and services etc between economic agents
what are the three withdrawals from an economy?
savings, government taxation, imports
what is the effect of withdrawals?
decreases the size of national income
what is the definition of GDP?
the market value of all the final goods and services produced in a given country
includes both citizens and non citizens within a country
what does nominal value mean?
its the breakdown of characteristics of an economy
what does GNI mean?
the total income generated by a countries citizens?
what is GNP?
the market value of all goods and services produces in one year by labour and properyty supplied by the citizes of a country
what are the evaluations of economic growth?
to what extent does it measure wellbeing effectively?
depends on how growth is achieved?
which groups in society benefit the most?
are you just considering growth in the short term?
magniture of benefits compared to costs of growth?
what is the balassa-samuelson effect?
when the prices of goods and services in poorer countries are cheaper because they are immobile
what is arbitrage?
when goods are purchased for cheap and resold at a higher price elsewhere
what is PPP and how is it calculated?
PPP compares a basket of goods + services and changes in price to reflect different costs of living and inflation.
to calculate: volume of goods produced by each country x price of the good in the US
what are the benefits and limitations of PPP?
no discrepancies
provides a base for comparison
however not all goods have an equivalent in the US
what is purchasing power?
the amount of goods you can get for one unit of currency
recall the characteristics of AD
purchasing power
interest rates
exports/imports
how does purchasing power affect AD?
people can purchase more with their income
assets worth more
induces the wealth effect
leads to higher consumption and investment
how does interest rates affect AD?
borrowing is cheaper
saving less attractive
higher consumption
how does exports/imports affect AD?
if prices are low, uk prices are more competitive compared to other countries]larger quanitity of exports sold
people opt for cheap UK goods, so imports fall
how do you calculate MPC?
change in consumption/ change in income
what are the factors affecting consumption?
consumer incomes
availability of credit
consumer confidence
changes in taxation
population
wealth effect
inflation expectations
what are the factors affecting investment?
paradox of thrift
economic growth
business expectations + confidence
demand for exports
interest rates
access to credit
government and regulation
relative prices of capital and labour
what are the factors affecting SRAS?
exchange rates
changes in taxation
cost of raw materials
how does changes in taxation. cost of raw materials and exchange rates affect SRAS?
taxation inc leads to inc in cost of production
increase cost of raw materials, inc cost of p
if exchange rate depreciates, cost of raw materials increases
all of these shift SRAS inwards
what is the definition of aggregate supply?
the potential output of all goods and services that are produced within an economy over a period of time
what are the factors affecting net trade?
relative inflation
exchange rates
cost of production
what is actual growth
Actual economic growth occurs when the current output level is below full capacity and therefore an increase in AD can lead to higher real GDP in an economy
what is an output gap
an output gap is the difference between real output (Y1) and potential output (Y*)
how can you evaluate the multiplier?
- There is a time lag involved- may not feel the effects until a later stage
- Measuring the multiplier effect may be difficult as it is hypothetical
- If the economy is close to full employment it may cause inflationary pressure
- MPM of a country may be high, which means that consumers are more likely to spend an additional unit of income on imports, which is a withdrawal from the economy
- If MPC is low, the rounds of spending will be lower
what are the two formula to calculate the multiplier? how do you calculate MPW?
1/MPW
1/(1 - MPC)
MPW= MPS + MPM + MPT
what are the macroeconomic objectives?
- Low unemployment
- Low+ stable rate of inflation
- Current account surplus
- Economic growth
- Balanced govt budget
- Balance of payment equilibrium
- Income equality
- environment
what are the targets for the govt macroeconomic objectives?
Target for inflation is 2%
Unemployment target is 3%
Target for balance of payments – 5% of GDP= sustainable
Economic growth- sustainable growth
why is strong economic growth needed
You need strong economic growth to increase employment as it creates new jobs-> higher incomes, reduce negative output gaps, inc c + I, increase LRAS
what is a current account deficit?
a current account deficit is when the outflow of money is greater than the inflow of money
what is the evaluation for the net impact of a current account deficit on the value of the pound?
more imports than exports means that supply inc is greater than demand in, net impact means that the value of the pound falls
what is the effect of a current account deficit on exchange rates if uk exports are high?
if uk exports are high, the demand for the pound is high, because to buy uk exports you have to buy the currency. So a current account deficit would cause for the exchange rate to appreciate
what is the effect of a current account deficit on exchange rates if uk imports are high?
if imports are high, the supply of the pound increases as people in the UK need to supply the pound in order to buy foreign currencies, so a current account deficit leads to the exchange rate depreciating
what is disinflation?
when level of inflation is falling, meaning that prices are rising more slowly
what is hedging
Hedging is when there is an agreement between firms and their supplier to purchase the good at a fixed price, which can delay cost push inflation
what are the impacts of high inflation?
- Wage price spiral
- Pay cut in real terms which would decrease consumption
- UK goods and services become less competitive as theyre more expensive
- Inc unemployment
- Dec business confidence
- Menu costs
what are the two methods used in the uk to measure unemployment?
Claimant count/ JSA
LFS -> labour force survey
what is claimant count + JSA?
The claimant count provides monthly data on the number of people claiming JSA/ unemployment benefits/ universal credit
JSA is when the govt provides support for those in society that require financial assistance. There is a set of conditions attached
what are the limitations of claimant count?
- Not every person who s unemployed is measured using claimant count
- Stigma attached to claiming benefits so they may not claim benefits
- Austerity
- If your partner earns too much you don’t qualify
- Most under 18s don’t claim JSA
- Some may purposefully not get a job
what is one reason for unemployment?
Real wage inflexibility- minimum wage set above equilibrium and the demand for labour is less than the supply of labour
what is inactivity?
neither employed nor unemployed/ not seeking work
what is underemployment?
workers who may not fully utilise their skills
what is hysteresis?
the longer someone is unemployed, the harder it is for them to find work
what are the 4 types of unemployment?
cyclical
seasonal
structural
frictional
what is frictional unemployment?
workers transferring between jobs
what is structural unemployment?
a mismatch between the skills of workers/ workers don’t have the required skills for certain jobs
what is seasonal unemployment?
industries which experience fluctuations throughout the year
what is cyclical unemployment
AD goes through a boom and bust cycle, therefore so does the demand for labour
- firms no longer need to produce as much output so they may let their workers go/ make them redundant during recession
- don’t need as many workers
what are the evaluations for unemployment?
- Usefulness of employment data
- Recruiting people takes time
- A company may prefer to take on people who can be let go of later if things go wrong
- helps explain why the economy is generating jobs but not much investment
- can be less costly than investing large sums in new machinery
what is the definition of AD?
total demand for goods and services in an economy at a given price level
what does the Philips curve show?
shows that inflation and unemployment have an inverse relationship
high inflation= low unemployment
when there is a high supply of workers without a job: wages fall, cost of p falls therefore inflation is lower
what is stagflation?
when there’s high unemployment and high inflation, which can be used as an evaluation point for the Philips curve
example of stagflation- 1970s Britain
what is the conflict between economic growth and inflation?
how can you evaluate this conflict?
if AD reaches full capacity- leads to high (demand pull) inflation
demand for factors of production increase- leads to (cost push) inflation
evaluation: depends on how much spare capacity there is in the economy
what does the Kuznets curve show?
can be used to evaluate the effect of growth on the environment
developed economies tend to be in a strong position to deal with their CO2 emissions after industrialisation
what is the conflict between inflation and current account?
how can you evaluate this conflict?
a countries international competitiveness can be damaged by higher prices- their exports would be more expensive
evaluation- just because prices are rising quicker doesn’t necessarily mean they are high
what is the conflict between growth + current account and how would you evaluate it?
when economic growth is strong, incomes are higher
MPM increases, imports increase-> current account deficit
evaluation- if growth is sustainable + inflation is low, consumers wont need to import
economic growth may be export led
strength of currency
what is the conflict between growth and income inequality and how would you evaluate it?
economic growth doesnt mean there will be an increase in incomes across the country
higher wages would reduce profits so owners lack incentive to increase them
evaluation: growth creates job opportunities
wages of those on lowest pay may rise faster than average wages
progressive tax redistributes income
what is the conflict between growth and govt finances and how would you evaluate it?
growth can be brought about by cut in tax or increased gov spending
expansionary fiscal policy would increase national debt
evaluation- depends on the proportion of growth brought about by debt
if the inc in GDP is greater than debt, debt to GDP ratio will fall
depends on economic state
how would you evaluate fiscal policy?
- expansionary fiscal policy will only be effective if the economy has spare capacity
- policy makers need good info on state on economy
- crowding out can be used instead of contractionary fiscal policy
what is fiscal policy?
it is the use of govt spending and taxation to manage the economy
what is crowding out?
- banks buy govt bonds as they are less risky than lending to private businesses
- this reduces the supply of loans and increases the market interest rate
- lack of lending to households and firms decreases C + I
does austerity work?
- if govt cuts spending, govt borrowing falls
- fewer bonds are issued
- so banks arent purchasing as many of these bonds
- more money freed up for lending
- inc C + I
this is also known as crowding in
how would you justify austerity?
- without austerity, national debt will continue to inc
- large national debt decreases confidence, decreasing AD
what are the drawbacks of austerity?
cost of living inc as wages dont inc in line with inflation-> less disposable income
cuts in peoples benefits
cuts in govt budgets
negative multiplier due to wider reduction in G spending
what is monetary policy and what is it used for?
the use of interest rates + money supply to manage the economy
what’s the impact of other countries increasing their interest rates on exchange rates?
what does this depend on?
hot money flow
depends on:
- relative interest rates
- transaction cost
- beauracracy
- trading blocs
what is the impact of rising interest rates on AD/AS?
slows down growth of AD but depends on state of the economy
what is forward guidance?
when bank of England provides assurances about the future levels of interest rates
this aims to inc confidence
describe the process of quantitative easing?
- BoE puts money into their own bank account
- they use this money to buy second hand govt bonds from banks
- banks now have more liquidity and seek alternative ways to invest the money
- banks are led away from buying govt bonds as the price is pushed up from the increase in demand by the BoE
- banks lend to households and firms
- inc supply of loans, dec high street interest rates
-inc I + C
how would you evaluate monetary policy?
- time lag
- unpredictable variables make interest rates slow to change price levels
- exogenous shocks
- could cause cost push inflation
- banks ultimately set their own interest rates
what is the credit crunch of 2008?
- confidence low, banks reluctant to lend as theyre unsure on whether huse holds + firms will pay b=them back
- higher interest rate
how would you use inflation to evaluate interest rates?
interest rates are mainly effective in combating demand pull inflation rather than cost pull inflation
how do you calculate CPI?
inflation rate measures change in average prices in an economy over a year
a survey of average prices is recorded
items are weighted according to proportion of spending on each product
why may quantitative easing be effective
should encourage banks to increase lending and hopefully increase C +I
inflation/GDP may have been lower without QE
confidence of markets would have been much lower without QE
lower interest rates encourages with encourages increased C + I therefore increasing AD and therefore inflation
depreciation of currency -> exports cheaper
why may quantitative easing not be effective
lack of confidence among firms and consumers -> may not respond to QE programme
banks may be reluctant to lend money due to financial crisis in 2008
time lags
if theres an extension of QE programme it suggests it hasnt worked
other policies may be more effective
what supply side policies can be used to make the product market more efficient, productive and competitive
privatisation
deregulation
infrastructure
what supply side policies can be used to make the labour market more efficient, productive and competitive
education and training- more skilled workforce
NMW- incentives
decrease power of trade unions
reduce unemployment benefits which encourages people to join the workforce and lower tax rates - incentives
what do supply side policies aim to do
aim to make the product and labour market more productive, efficient and competitive which shifts LRAS outwards
what do supply and demand side policies do
allow the govt to achieve macroeconomic objectives
so when a question that asks about the impact something has on the global/macro economy - refer to how something impacts the government macroeconomic objectives
what are the factors affecting LRAS
- land, labour, capital (quantity of factors of production)
- discovery of new materials
- inward migraton
- quality of factors of production
- education/ training
- R+D could affect efficiency of capital
- technological advancement
what is the definition of unemployment
number of people who are willing and able to work but do not have a job despite an active search
what does the labour force survey do
looks at number of people willing and able to work in the next 2 weeks but have been unemployed in the last 4 weeks
tends to be more accurate
how does relative prices of capital and labour affect investment
if capital is cheaper than labour then firms may invest more in capital to decrease their cost of production
what is the accelerator effect
when an increase in national income results in a proportionately larger rise in capital investment spending
so when theres an increase in growth then
means theres more consumer confidence and therefore more consumption
this increases business confidence
so firms will spend more on capital (increase investment) to increase output
what are the 4 stages of the trade cycle
boom
recession
downturn
recovery
what is a recession
negative growth over to consecutive quarters
draw the trade cycle diagram
how do you measure inflation
a basket of 650 goods
family expenditure survey which is used to find out consumer spending habits
what is the definition of demand pull inflation
when there is an increase in AD which causes an increase in general price levels
what is the definition of inflation
a sustained increase in the general price level
what are the two formulae for calculating the value of the multiplier
1/1-MPC = K
K= multiplier
change in Y/ change in J = K
Y= national income
J= injections
