Theme 2

Question 1

Negative output gap

Answer 1

When actual GDP is below the potential trend GDP. The economy is not using it’s resources efficiently

Question 2

Positive output gap

Answer 2

When actual GDP is above the potential trend GDP. Th economy is running above it’s potential e.g. workers working overtime

Question 3

Neo-classical LRAS curve

Answer 3

The straight vertical line

Question 4

Negative output gap on the LRAS

Answer 4

When equilibrium of SRAS is below LRAS

Question 5

Reasons why there may be an increase in unemployment

Answer 5

1. Uncertainty over the process of leaving the EU -> uncertainty discourages firms from expanding / investing into their business
2. Closure of high street shops -> high street shops employ a large number of people in the UK and shops are instead moving online
3. Falling incomes -> lower incomes lead to lower consumption so less demand for labour
4. Deflation/ slower economic growth -> may have to reduce staff costs therefore may have to cut staff numbers instead of wages.

Question 6

Multiplier effect

Answer 6

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 Eventually all money is withdrawn/leaked out the circular flow of income.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

Question 7

What do PPPs do

Answer 7

• 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

Question 8

Limitations of GDP when measuring living standards

Answer 8

• 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

Question 9

CPI

Answer 9

• 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

Question 10

Limitations of the CPI

Answer 10

• only represents the average household.
• different demographics have different spending patterns
• too slow to respond to new goods and services (updated annually)

Question 11

Causes of inflation

Answer 11

• 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

Question 12

Quantitative easing

Answer 12

• 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

Question 13

Automatic stabilisers

Answer 13

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

Question 14

Discretionary fiscal policy

Answer 14

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

Question 15

Pros and cons of high interest rates (contractionary monetary policy

Answer 15

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

Question 16

Reasons for fiscal policy

Answer 16

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

Question 17

Pros and cons of contractionary fiscal policy (austerity policies)

Answer 17

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

Question 18

Factors influencing SRAS

Answer 18

• 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.

Question 19

Factors influencing LRAS

Answer 19

• 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.

Question 20

Government,ent regulations that can effect LRAS

Answer 20

• 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

Question 21

Consequences of inflation

Answer 21

g- uncertainty causing a fall in investment
- menu costs and shoe leather costs