Theme 2 Flashcards
Negative output gap
When actual GDP is below the potential trend GDP. The economy is not using it’s resources efficiently
Positive output gap
When actual GDP is above the potential trend GDP. Th economy is running above it’s potential e.g. workers working overtime
Neo-classical LRAS curve
The straight vertical line
Negative output gap on the LRAS
When equilibrium of SRAS is below LRAS
Reasons why there may be an increase in unemployment
- Uncertainty over the process of leaving the EU -> uncertainty discourages firms from expanding / investing into their business
- Closure of high street shops -> high street shops employ a large number of people in the UK and shops are instead moving online
- Falling incomes -> lower incomes lead to lower consumption so less demand for labour
- Deflation/ slower economic growth -> may have to reduce staff costs therefore may have to cut staff numbers instead of wages.
Multiplier effect
Where an initial change in aggregate demand can have a greater final impact on equilibrium national income. Eventually all money is withdrawn/leaked out the circular flow of income. One person’s spending is another person’s income
- value of multiplier = 1/ 1-MPC
What do PPPs do
- measure the total amount of goods and services that a single unit of a country’s currency can buy in another countrys currency
- helps to make more meaningful comparisons and contrasts between countries
Limitations of GDP when measuring living standards
- fails to account for non-market activities like volunteering, caregiving, stuff important to people’s well-being
- ignores distributional issues like poverty and inequality
- environmental and negative externalities
- doesn’t capture subjective well-being measures like happiness
CPI
- the CPI (consumer price index) measure the average change of prices over time
- it is calculated by collecting data on the prices of a basket of goods.
- the baskets are given weights
Limitations of the CPI
- only represents the average household.
- different demographics have different spending patterns
- too slow to respond to new goods and services (updated annually)
Causes of inflation
- demand-pull inflation: when demand for gods and services exceeds supply in the economy
- cost-push inflation: when overall prices increase due to an increase of wages and raw materials. Higher costs of productive. Causes a decrease in AS
Quantitative easing
- the central bank purchases financial assets, such as government bonds from banks
- this injects only into the economy, giving banks more money to lend
- as the central bank buys assets, it increases their demand which leads t higher prices and lower yields
- this reduces interest rates in the economy making borrowing cheaper
- encourages businesses to invest and consumers to spend
- leads to a increase in price of financial assets such as stocks , this can create a wealth effect, encouraging consumer spending
-economic activity
Automatic stabilisers
Automatic fiscal changes as the economy moves through stages of the business cycle
- e.g. progressive tax
- in a positive output gap you would expect less government spending and more tax revenue as part of automatic stabilisers
Discretionary fiscal policy
A deliberate altercation of government expenditure/taxation designed to achieve its economic objectives
- in a negative output gap you would expect more government spending/ less tax revenue as part of automatic stabilisers
Pros and cons of high interest rates (contractionary monetary policy
Pros:
1. A decrease in demand pull inflation (However not to successful if cost push inflation)
2. Discourage household and corporate debt -> reducing risk of recession
3. More sustainable borrowing -> only people that can afford borrow -> stops unsustainable borrowing, from people that cannot repay for example.
4. Encourage more saving -> those living off savings better standard of living -> pensioners
5. More affordable housing -> increase cost of mortgages -> decrease house prices -> improve social mobility
6. Reduce CA deficit -> by reducing incomes
Cons:
1. Shocking the economy into recession -> discouraging consumption -> exchange rate, exports imports -> decrease AD -> could cause a recession
2. Higher unemployment -> business cant afford to pay their loans
3. Impact on indebted
4. Reduces investment -> bad for SR and LR growth -. Less productivity
5. Worsening the current account deficit -> hot money flows as more return for savings -> increase demand for pound -> increase value of pound -> exports more expensive
Reasons for fiscal policy
Reasons for expansionary
1. Increase economic growth
2. Reduce cyclical unemployment -> AD shifts to the right
3. Increase demand pull inflation
4. Redistribution of income
Reasons for contractionary
1. Reduce inflation
2. Reduce budget deficit
3. Redistribute income - > higher taxation on he rich
4. Reduce current account deficit -> AD reduced -> incomes lower -> less imports -> reduce trade deficit
Pros and cons of contractionary fiscal policy (austerity policies)
Pros:
- Will give confidence in gov finances -> reducing national debt -> improved credit rating on gov bonds as less risky borrow -> governments can issue lower interest rates -> cheaper to borrow over time -> can attract FDI
- Flexibility with fiscal policy: less spending on debt interest -> freeing up higher government spending where necessary -> can afford services in recession
- Less crowing out of private sector -> less pressure on demand on loan le funds market -> interest rates low -> private sector can borrow with low interest rates still
- Lower demand-pull inflation and CA deficit
Cons:
- Demand side shock by reducing aggregate demand -> recessionary outcomes -> higher unemployment -> lower living standards
- Depends what spending is cut -> e.g. less on education (Micro). Can harm LRAS productivity and competitiveness
- LR returns of spending better
- incentive distortions -> laffer curve -> less incentive for growth -> more incentive to avoid tax -> lower tax revenues potentially
- Risk increase of income inequality
EVAL:
- necessary to run a budget surplus?
- Can end up reducing GDP, which would mean deb to GDP ratio could be rising
Factors influencing SRAS
- Changes in costs of raw materials and energy: SRAS will shift to the left as costs more to make the same amount of goods
- Changes in exchange rates: A weaker pound will lead to an increase for the price of exports. Will shift SRAS to the left as production becomes more expensive
- Changes in tax rates: taxes increase cost of production, SRAS shifts to the left.
Factors influencing LRAS
- Technological advances: improvements in tech will shift LRAS to the right. Will speed up production so more goods will be produced with the same amount of resources
-Rrelative productivity: The more productive an economy, the more will be produced with the given resources. Depends on efficiency, skill of labour, technology -> investment may increase as a result - Education and skills: A more skilled workforce will be more employable and work quicker and more efficiency -> output per worker will increase. LRAS to the right -> education could be used to improve mobility of labour, decreasing structural unemployment
- Government regulation
- Demographics and migration: if immigration is higher than emigration, population will grow, shifting LRAS to the right. Depending on age of immigrants
- Competition policy: the government can promote competition between business and markets, forcing them to improve quality of labour.
Government,ent regulations that can effect LRAS
- Can decrease economic activity: e.g. making childcare free
- Decreasing unemployment: decreasing benefits, change the working age
- Increase research and development: can offer tax breaks o business who invest money into research
- Make it easier to set up businesses: e.g. lower corporation tax
Consequences of inflation
g- uncertainty causing a fall in investment
- menu costs and shoe leather costs
