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A Level Economics - Edexcel > Theme 2 Content > Flashcards

Theme 2 Content Flashcards

1
Q

2.1 Measures of economic performance

What is economic growth / decline?

2.1.1 - Economic growth

A

An increase / decrease in the total production or productive potential of an economy.

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2
Q

2.1 Measures of economic performance

How is economic growth measured

2.1.1 - Economic growth

A

Economic growth is typically measured by calculating the percentage change in real GDP over a specific period, such as a year.

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3
Q

2.1 Measures of economic performance

What is National Income?

A

The total value of income received by households, from firms (in exchange for CELL) in an economy.

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4
Q

2.1 Measures of economic performance

Causes of inccuracy of national income statistics (4)

A
  • Statistical inaccuracies due to quality of data collecting agencies
  • Hidden economy/shadow economy not being counted
  • Home produced goods
  • Public sector (hard to value output)
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5
Q

2.1 Measures of economic performance

Problems with NI (5)

A
  • Inflated prices - decreases purchasing power so may be less well off for same national income
  • Per capita representation needed
  • No account of quality
  • Externalities, future costs not factored
  • Income distribution not accounted for
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6
Q

2.1 Measures of economic performance

How does the development of a country affect National income data?

A

Developing countries could have poor data collection agencies - meaning the quality of the GDP data could be weak.

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7
Q

2.1 Measures of economic performance

Since National Income data doesn’t account for shadow markets, what do some countries do?

A

Add an estimate of the value of their shadow market.

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8
Q

2.1 Measures of economic performance

What is the shadow economy?

A

Illegal activities that create GDP but are not recorded in the formal economy.

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9
Q

2.1 Measures of economic performance

What is PPP used for?

A

To compare between countries.

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10
Q

2.1 Measures of economic performance

What are the benefits of PPP?

A
  • Easily compared - ppp exchange rates remain fairly constant.
  • Exchange rates get closer to the PPP over time.
  • Can track and predict exchange rate relationships.
  • Examine the relative living conditions of different countries.
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11
Q

2.1 Measures of economic performance

What are the issues with GDP?

A

Inaccuracy of data, inefficiencies in data collection, over time methods change.
Expenditure does not = quality of life.
Doesn’t include reproductive labour.
Doesn’t take into account home-produced services (e.g. DIY).

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12
Q

2.1 Measures of economic performance

With reference to Figure 2, assess whether an increase in real incomes improves subjective happiness within the UK. (2022)

A

For

  • More money for consumer goods, luxury goods, treats, holidays. –> Improves happiness
  • Finacial security, ability to save. Less likely to experience hardship. People on benefits are unlikely to have financial security.

Against

  • People who work need to work longer hours, more responsibilities, more stress. They might not be able to enjoy the extra income.
  • Depends on age/if there are dependents. Depends on the level of benefits being provided by the state.
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13
Q

2.1 Measures of economic performance

Factors affecting national happiness?

A

Life satisfaction
Anxiety
Happiness
Worthwhileness

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14
Q

2.1 Measures of economic performance

What are the 3 ways to measure GDP?

A

Output
Income: GNI
Expenditure

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15
Q

2.1 Measures of economic performance

How is green GDP calculated?

A

GDP - environmental costs.

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16
Q

2.1 Measures of economic performance

What does ↑ Real GDP mean?

A

↑ Value of goods and services.
so it should mean, ceteris paribus, that incomes and standards of living are rising

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17
Q

2.1 Measures of economic performance

What is a higher GDP is often correlated with?

A

Higher incomes and so a higher standard of living.

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18
Q

2.1 Measures of economic performance

What is inflation?

A

The general increase of price levels in an economy.
(Consumer Price Index).

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19
Q

2.1 Measures of economic performance

What is deflation?

A

General fall in price levels

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20
Q

2.1 Measures of economic performance

What is disinflation?

A

A reduction in the rate of inflation.

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21
Q

2.1 Measures of economic performance

What is Demand Pull inflation?

A

Inflation caused by increased in Aggregate Demand.

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22
Q

2.1 Measures of economic performance

What is Cost Push Inflation?

A

Inflation caused by increase in the cost of production.
(decrease in Aggregate supply).

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23
Q

2.1 Measures of economic performance

What makes up the basket of goods in the UK to measure inflation?

A

180,000 prices are measured across thousands of outlets.

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24
Q

2.1 Measures of economic performance

What are the 3 causes of inflation?

A
  • Demand-pull.
  • Cost-push.
  • Growth of money supply. (More money than G+S raises prices). [Fisher equation].
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25
Q

2.1 Measures of economic performance

What is Fisher’s equation, which describes the relationship between inflation and real interest rate?

A

Real interest rates = nominal interest rates - inflation.

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26
Q

2.1 Measures of economic performance

How can inflation be measured?

A

CPI or RPI

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27
Q

2.1 Measures of economic performance

How does inflation indicate the strength of the economy?

A

High and unexpected inflation means goods and services are becoming unaffordable - purchasing power of income falls.

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28
Q

2.1 Measures of economic performance

What are the effects of inflation on households?

A
  • Increased spending increase MPC. - as goods are more expensive
  • Reduction in the real value of debt
  • Wage demands
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29
Q

2.1 Measures of economic performance

What are the effects of inflation on firms?

A
  • Less internationally competitive
  • Increased costs (due to wage demands).
  • Lower confidence (less animal spirits).
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30
Q

2.1 Measures of economic performance

What are the effects of inflation on government?

A
  • Revenue from indirect taxes will fall (spending dec).
  • Revenue from direct taxes will rise (as wages inc).
  • Reduction in the value of real govt. debt.
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31
Q

2.1 Measures of economic performance

How is CPI measured? How is a basket of goods created from CPI?

A

Via a family expenditure survey.
From this, basket of goods = created, weighted due to amount of expenditure on each item.

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32
Q

2.1 Measures of economic performance

What are the limitations of CPI?

A

Basket of goods only represents average household.
Different demographics have different spending patterns.
Slow to respond to new goods and services.
Hard to make historical comparisons.

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33
Q

2.1 Measures of economic performance

What does the RPI value tend to be?

A

Higher than CPI.
(Includes interest rates on mortgage payments, council tax etc).

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34
Q

2.1 Measures of economic performance

What does the RPI exclude?

A

Top 4% of earners and low income pensioners. (As they are not ‘average households’).

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35
Q

2.1 Measures of economic performance

What does the RPI not take into account?

A

When prices rise people will switch to product that has gone up by less, unlike the CPI.

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36
Q

2.1 Measures of economic performance

What causes demand-pull inflation?

A
  • Depreciation in the exchange rate. (WIDEC) - AD increases. (Less imports, improved trade balance)
  • Lower taxes or more Government spending. ↑ Disposable income.
  • Lower interest rates - save less and more borrowing + consumption.
  • High growth - export more and AD increase.

(Anything that increases AD).

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37
Q

2.1 Measures of economic performance

Give 4 factors that could cause cost push inflation:

A
  • Increase in price of Land/Labour - (raw mat / cost of labour)
  • Expectations of inflation - wage demands = ↑ Cost of Production.
  • Increase in indirect taxes, these costs are passed on.
  • The presence of monopoly power. Firms have more price control and set higher prices.
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38
Q

2.1 Measures of economic performance

What is the risk when inflation continually rises?

A

Price rises harm the economy.
Shut down of businesses, AD rapidly declines.

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39
Q

2.1 Measures of economic performance

Causes of long-run economic growth (6)

A
  1. Land - Some countreis eg Saudi Arabia have seen extensive growth due to natural resources
  2. Labour - Increases in the quantity of workers through demographic changes and migration - Or increases in the labour productivity of the existing labour force
  3. Capital - Stock of capital needs to grow in order to sustain increasing output - Both physical and human
  4. Technological progress - Can bring new products onto the market to sell -> extra spending - Reduces existing costs due to efficiency increases eg computers and calculators
  5. Efficiency - Increased efficiency -> rises in output - In a market economy, competition should lead to greater efficiency
  6. AD - Generally associated with export-led growth eg with China - LRAS can be expanded through the investment of export earnings
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40
Q

2.1 Measures of economic performance

Why does long-run economic growth occur

A

Productive potential will shift outward if there is a greater number of resources available to produce with or if the process of production becomes more efficient

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41
Q

2.1 Measures of economic performance

The costs of deflation (5)

A
  • Asset values decrease
  • Savers watch money grow prompting an increase in MPS
  • Low levels of consumer confidence
  • Low levels of business confidence
  • Growing national debt in nominal terms
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42
Q

2.1 Measures of economic performance

Costs of high inflation (6)

A
  1. Growth/unemployment -> Difficult planning -> Reduced investment -> Decreased consumer spending
  2. Competitiveness -> Higher inflation relative to trading partners leads to decreased exports and increased imports -> Leads to loss of domestic industry
  3. Redistributional costs -> When workers are unable to re-negotiate wages, pensions are affected -> Loans and mortages decrease in value, good for borrowers and bad for lenders
  4. Shoe-leather costs -> Consumers become unsure about prices leading them to shop around more -> This in of itself is a cost
  5. Menu costs -> Changing / adopting prices
  6. Loss of confidence -> Firms lose confidence leading to reduced investment
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43
Q

2.1 Measures of economic performance

Effect of Inflation on workers

A

While workers may see nominal wage increases, their real wages may decline due to inflation.
Labor unions may negotiate for higher wages to keep pace with rising prices.

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44
Q

2.1 Measures of economic performance

What is Claimaint Count?

A

The number of people claiming unemployment benefits.

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45
Q

2.1 Measures of economic performance

What is unemployment - UK Labour Force Survey? (International Labour Organisation definition).

A

Those of working age without work, able and seeking work, available for work in the next 2 weeks.

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46
Q

2.1 Measures of economic performance

What are the possible Employment statuses?

A
  • Employed
  • Unemployed
  • Underemployed
  • Inactive.
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47
Q

2.1 Measures of economic performance

What are the 5 types of Unemployment?

A
  • Frictional - between jobs (short-term)
  • Structural - where the industry has shrunk so people with specialist skills are left unemployed
  • Seasonal - lifeguards
  • Cyclical - busienss cycle
  • Real Wage. - real wages level is above equilibrum - excess supply of labour
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48
Q

2.1 Measures of economic performance

The costs of unemployment (3)

A
  1. Costs to themselves
    Most likely lose out, loss of income, some may be offset by welfare
    Stigma leads to poor health
    Longer unemployed = harder to get a job
  2. Cost to economy
    Loss of output the unemployed could have produced
    Less able to be consumed for consumers
    Social costs such as increased crime
  3. Costs to firms
    Firms suffer because the unemployed represent loss of potential demand
    Full employment is preferable
    Could be lower wage rates however
    Long-term unemployment represents a loss of human capital as workers become de-skilled
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49
Q

2.1 Measures of economic performance

Why does underemployment tend to increase in a recession?

A

Firms tend to reduce staff hours, as opposed to making them redundant (and paying expensive redundancy packages).

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50
Q

2.1 Measures of economic performance

What is the employment / unemployment rate?

A

The percentage of economically active people who are employed / unemployed.

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51
Q

2.1 Measures of economic performance

Give examples of underemployed people:

A

Those in part time or zero hour contracts, in jobs which do not reflect their skill level.

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52
Q

2.1 Measures of economic performance

What is the criteria for claiming unemployment benefits (thus being included in claimant count)?

A
  • over 18
  • not in full time education
  • available to work
  • actively seeking work
  • < £16,000 in household savings

(CLAIMANT COUNT DEF OF UNEMPLOYMENT)

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53
Q

2.1 Measures of economic performance

What are the impacts of unemployment on households?

A
  • Loss of income
  • Stigma
  • Loss of skills
  • Lower job security for the employed
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54
Q

2.1 Measures of economic performance

What are the impacts of unemployment for firms?

A
  • Fall in sales / profits.
  • Smaller pool of skilled workers.
  • Lower wages (as there is increased supply of labour).
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55
Q

2.1 Measures of economic performance

What are the impacts of unemployment for Government?

A
  • Fall in tax revenue
  • Increased spending on benefits
  • Social deprivation
  • Loss of national output
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56
Q

2.1 Measures of economic performance

What are the factors that determine the demand for labour?

A
  • Demand for the product the labour produces- Labour is a derived demand
  • Marginal revenue product, the extra revenue generated by an individual worker.
  • Productivity (output per worker) - There is higher demand for more skilled labour that can produce more output.
  • Legislation - compulsory workers rights (paid holidays, prension) make it more expensive to hire labour and lower demand.
  • Price of capital/technology (assuming substitues) - if capital becomes cheaper, demand for labour will be lower.
  • Improvements in technology - robitics/software advancements will reduce demand for labour. - By 2040, about 47% of jobs could be lost to technology, according to Oxford university
  • Wage rates
  • State the economy - Business confidence about future profits.
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57
Q

2.1 Measures of economic performance

What are the factors that influence the supply of labour?

A
  • Wages - High wages creates high incentives to work.
  • Birth rates and migration - Large population means large supply of labour. Age determines if population can work.
  • Non-monetary benefits - Supply of labour will increse if there is high job satisfaction. Healthcare, pension, social factors, location, holidays, flexibility, opportunity for promotion.
  • Education/training/qualification - More educated workers means there is a higher supply of workers.
  • Trade unions - Restrict the supply of labour by introducing barriers to entry. You need a degree to teach. Must work for TFL for 2 years before you can become a train driver.
  • Working conditions and wages for other jobs
  • Legislation - Retirement age, school leaving age.
  • High government benefits - reduce the incentive to work.
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58
Q

2.1 Measures of economic performance

Ways to improve the skills and quality of the labour force (3)

A
  1. Education
    • Education is provided by state to ensure that everyone recieves training
    • The legal age in which you can leave education can be increased in order to ensure the level of education is higher
  2. Training
    • Firms in the free market tend to undertrain leading the gov to intervene in the market
    • Gov provides subsidies in order to increase the quantity of the population who has recieved training
  3. Immigration
    • Importing highly educated people will increase the competency of the existing labour force
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59
Q

2.1 Measures of economic performance

Significance of Migration and Skills for Employment and Unemployment:

A
  • Migration can impact employment by changing the supply of labor in specific regions. Immigrants may fill labor gaps, but this can also lead to wage pressures.
  • Skills are crucial for employment. A highly skilled workforce is more adaptable and less prone to unemployment in a changing economy.
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60
Q

2.1 Measures of economic performance

What is Balance of Payments?

A

Record of all financial dealings over a period of time.
Between economic agents of one country and all other countries.

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61
Q

2.1 Measures of economic performance

What is the Current Account of the Balance of Payments? (TTIT)

A
  • (Balance of) trade in goods
  • (Balance of) trade in services
  • (Net) income flows from abroad
  • (Net international) transfer payments.
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62
Q

2.1 Measures of economic performance

What are the causes of a current account balance of payments deficit?

A

Not enough exports
* Lack of productivity and competitiveness
* High inflation
* High currency value
* Non price factors like poor quality and design

High imports
* High curency value
* Spending habits

Other factors
* Monetary policy
* Supply side policies
* Fiscal policy
* Trade cycle - Boom times may mean higher imports. (Depends on MPI)

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63
Q

2.1 Measures of economic performance

What are the causes of a balance of payments surplus?

A
  • Competitive economy - High productivity, investment, training, quality
  • Low inflation
  • Low exchange rate
  • Vast natural resource - Kuwait, UAE
  • Trade cycle
  • Government policies - competitive supply side policies
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64
Q

2.1 Measures of economic performance

What are the problems with having a large balance of payments deficit?

A
  • Signals a long term loss of competitiveness
  • May mean higher unemployement - Withdrawl from circular flow, drag on aggregate demand
  • May create imported inflation - Leads to a falling exchange rate - higher import costs.
  • Fall in GDP - Withdrawl from circular flow
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65
Q

2.1 Measures of economic performance

Why might having a balance of payments deficit not be so bad

A
  • Depends on the size of the deficit and how long it persists - Might be cyclical
  • Depends on what the imports are - capital goods and investment will improve future growth prospects.
  • Depends on if the exchange rate is fixed or floating, In a floating system, the balance of payments deficit should be self correcting
  • Might be financed by a surplus on the financial account
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66
Q

2.1 Measures of economic performance

What are the problems of having a large balance of payments surplus?

A
  • Retaliation - Countries with large deficits might retaliate by putting up barriers to trade to reduce imports - American withdrawl from NAFTA
  • Resources are focused on producing to meet export demand rather than export demand, so lower consumer living standards
  • Rise in the exchange rate - makes exports more uncompetitive in the long run.
  • Inflation - high demand for exports could create inflation.
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67
Q

2.1 Measures of economic performance

How can contractionary fiscal policy be used to correct a balance of payments deficit and what is the problem?

A
  • Fiscal policy - Raise income tax - Consumers have less disposable income. Spend less and import less. Particularly effective for countries with a high MPI.

Evaluation
* Unemployment and lower growth. Less incentives
* Fall in consumption and investment - less aggregate demand means lower business confidence

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68
Q

2.1 Measures of economic performance

If a country has a current account deficit, it must have a surplus on the other elements of the balance of payments. Why is this?

A
  • This is because it has to pay for everything it consumes and funds in some way - to fund a current account deficit, a country must be selling assets to foreign investors.
  • It is debatable whether this is sutainable in the long run since, if people invest in a country, at some point they will require a return on their investment, and this will cause a deficit on the financial account
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69
Q

2.1 Measures of economic performance

Balance of payments - balancing item

A
  • The balance of payments must always equate to 0
    -> if the government runs a current account deficit, it must run a capital and financial accounts surplus
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70
Q

Measures to reduce current account imbalances (5)

A
  1. Exchange rate changes
    -> If an economy is running a persistent deficit, then a currency devaluation is likely to increase exports and decrease imports thus improving the current account
    -> A cheaper £ makes imports more expensive for domestic buyers and exports cheaper for foreign buyers
    -> This assumes that the combined elasticity of demand for exports and imports is greater than one -> the Marshall-Lerner condition
    -> In the short term, there may be a deterioration of the current account due to the J-curve effect, but in the long term it should improve
    -> Devaluation is an example of expenditure switching policy
    -> Expenditure is swithced from higher priced imports to more competative domestically produced goods
    -> It should be remembered that a devaluation is incredibly hard and expensive to do on a free floating currency
  2. Deflationary policies
    -> Policies aimed at reducing AD
    -> Eg by increasing interest rates or taxes
    -> Households will have less disposable income and therefore will cut back spending on foreign products
    -> Equally firms will cut back investment including purchases of imported capital
    -> imports decline
    -> Exports could increase if firms switch sales from the depressed domestic market to foreign markets
    -> Examples of expenditure reducing policies
    -> Could alternately use reflationary policies to reduce a surplus
  3. Supply side policies
    ->Supply side policies aimed at reducing unit labour costs and increasing investment, increasing human capital in the labour force should lead to increased exports and reduced imports
    -> Major problem being that they are long term policies
    -> Work by increasing productivity which decreases production costs and thus make exports cheaper, increasing the demand
    -> Also make domestically produced goods more competative in relation to foreign imports
  4. Protectionism
    -> Increasing tariffs or quotas will reduce imports and thus improve the current account
    -> Only effective if they are not met with retaliation
  5. Currency controls
    -> Government may choose to impose or tighten currency controls
    -> These are controls on the purchase of foreign currency by domestic citizens and firms
    -> Used today in Russia and Pakistan
    -> Limit the amount of imports that can be bought and thus improve the current account
    -> Black markets are likely to occur however
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71
Q

2.2 - Aggregate Demand

What is marginal propensity to consume (MPC)?

A

The proportion of an increase in income spent on consumption.
change in consumption / change in income.

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72
Q

2.2 - Aggregate Demand

What are MPM, MPS, MPT, MPW?

A

Marginal Propensity to: Import, save, tax, withdraw.

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73
Q

2.2 - Aggregate Demand

Determinants of consumption (5)

A
  • Interest rates
  • Consumer confidence
  • Wealth effects
  • Availability of credit
  • Inflation
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74
Q

2.2 - Aggregate Demand

Determinants of investment (7)

A
  1. The rate of interest
    -> Through making new venture cheaper
    -> Through making saving retained profit less attractive
  2. Business confidence
    -> If firms expect sales to increase they are more likely to invest in capital to meet that expected demand
    -> If firms expect sales to fall they will reduce investment in anticipation
    -> Animal spirts
  3. Retained profit
    -> 70% of UK investment is through retained profit
    -> Firms will consider opportunity cost of investment, the more retained profit the more likely they are to invest
  4. Government taxes / regulation
    -> Cutting tax on profits will increase investment as profits are higher due to lower costs
    -> Governments can encourage investments by guarenteeing loans used to invest with
    -> Excessive regulation decreases profitablity and thus investment as costs are increased
    -> Crowding out
  5. Demand for exports.
  6. Rate of economic growth
  7. Technological change
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75
Q

2.2 - Aggregate Demand

Determinants of Government Spending [5]

A
  • Political Factors: Government priorities, party policies, and political stability can significantly impact spending decisions.
  • Social Needs: Demographic changes, such as aging populations, can increase expenditure on healthcare and pensions. Example: Japan’s rising healthcare costs due to its aging population.
  • Economic Conditions: Inflation rates, unemployment levels, and economic growth can affect government spending. Example: Increased unemployment benefits during high unemployment periods.
  • Debt Levels: High public debt can constrain government expenditure due to the need for debt servicing. Example: Greece’s austerity measures post-2008 financial crisis.
  • External Factors: International events, trade relations, and global economic conditions. Example: Increased defense spending during geopolitical tensions.
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76
Q

2.2 - Aggregate Demand

What is the primary relationship between savings and consumption in economics?

A

As savings increase, consumption tends to decrease, and vice versa.

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77
Q

2.2 - Aggregate Demand

What is wealth effect?

A

When a change in personal wealth influences consumer spending and economic growth.

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78
Q

2.2 - Aggregate Demand

What are the factors affecting G? (TC,R,B)

A
  • Trade cycle - eco growth fluctuates within different phases:
  • Recession - G ↑ to increase D ∴ reducing unemployment - G ↑ more spending on unemployment benefits
  • Booms - G ↓ to decrease AD and reduce inflation
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79
Q

2.2 - Aggregate Demand

Factors influencing net trade? (QPREPS)

A
  • Quality and Innovation
  • Prices (high prices of UK goods = less competitive).
  • Real Income (inc. M)
  • Exchange Rates (SP or WP?).
  • Protectionism (means less X).
  • State of world economy
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80
Q

2.3 - Aggregate Supply

What is short run aggregate supply?

A

The total amount of output in the economy at any given price at a moment in time. (cost of production).

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81
Q

2.3 - Aggregate Supply

Why is the (classical) SRAS curve upward sloping?

A

To increase AS, this takes time - e.g. to build new facilities.
∴ ↑ AS, ↑ costs

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82
Q

2.3 - Aggregate Supply

Classical LRAS graph:

A
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83
Q

2.3 - Aggregate Supply

Keynesian LRAS graph:

A
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84
Q

Causes of AS-led growth:

A

Quantity + quality of fop: CELL
Improved productive efficiency (e.g. due to competition).

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85
Q

Causes of AD-led growth:

A
  • Increased consumer spending.
  • Increased net exports.
  • Increased net govt. spending.
  • Increased investment.
  • (Increase in any component of AD).
86
Q

Evaluation of AD-led growth:

A

Consumers on lower incomes will see a reduction in living standards, as their purchasing power decreases.
(Due to demand-pull inflation).

87
Q

2.3 - Aggregate Supply

Why is keynesian LRAS graph curved?

A

As AD increases, more pressure is put on FoP, causing increased prices.
Bottlenecks e.g. not enough skilled labour.
Diminishing returns to production.

88
Q

2.3 - Aggregate Supply

What is an outward shift of the Keynesian LRAS curve equivalent to?

A

An outward shift on a PPF

89
Q

2.3 - Aggregate Supply

Give 6 factors that could shift LRAS outwards:

A
  • Tech. advances.
  • Increase in relative productivity.
  • More skilled workforce / education to improve occupational mobility to reduce structural unemployment.
  • Change in govt. regulation.
  • Demographic changes + migration.
  • Policies inc. competition (inc quality + lower prices).
90
Q

2.3 - Aggregate Supply

How could an increase in the UK’s relative productivity shift LRAS outwards?

A

It could encourage investment into production of that good.
Also increases quality of labour / quality of FoP.

91
Q

What is the interest rate effect?

A

An increase in prices causes an increase in interest rates.
(In an attempt to curb C, I, G so demand-pull inflation ↓).

92
Q

How can age distribution of the population influence G?

A

More dependents = higher G.
(Pensions, social care etc.)

93
Q

2.3 - Aggregate Supply

What is hysteresis?

A

The economy never fully recovers from a deep recession.
Loss of potential employment, as workers become discouraged, natural rate of unemployment increases.
Inward shift in LRAS.

94
Q

2.3 - Aggregate Supply

What are the factors affecting SRAS? (CREST)

A

Cost of raw materials
Regulations
Exchange rates
Supply Shocks
Taxes

95
Q

2.4 - National Income

What are the withdrawals of the circular flow of income?

A
  • Taxes
  • Imports
  • Savings
96
Q

2.4 - National Income

What are the injections to the circular flow of income?

A
  • Government spending
  • Exports
  • Investment
97
Q

2.4 - National Income

Define circular flow of income

A

The flow of money in the economy between different sectors - households, firms, .+ identification of features, such as withdrawals or injections from the circular flow.

98
Q

2.4 - National Income

What are injections?

A

The money in the circular flow of income which enters the country.

99
Q

2.4 - National Income

What are withdrawals?

A

Money in the circular flow of income leaving the economy.

100
Q

2.4 - National Income

Draw the circular flow of income diagram

A
101
Q

2.4 - National Income

Explain the difference between income and wealth

A

Income is a flow of money
Wealth is a stock of assets

102
Q

2.4 - National Income

How does the multiplier effect lead to a further increase in AD and national income?

A
  1. Initial injection increases AD.
  2. Multiplier creates income for people, facilitating spending.
  3. Leads to another increase in AD.
  4. Multiplier creates more income for people, facilitating spending.
  5. AD settles at a new equilibrium.
103
Q

2.4 - National Income

What is the symbol given to the multiplier (effect)?

A

K

104
Q

2.4 - National Income

What does the extra consumption, due to multiplier effect create?

A

Extra jobs, increasing output.

105
Q

2.4 - National Income

When does a negative multiplier effect occur?

A

When withdrawals are made.
(Government cuts in fiscal spending will lead to an even bigger decrease in economic activity).

106
Q

2.4 - National Income

Where do the government target injections?

A

On those that will have the largest effect on the multiplier.
(Largest MPC).
(Example is redistributing income to those on lower incomes with higher MPCs).

107
Q

2.4 - National Income

Give the 3 evaluations of the multiplier effect:

A
  • Uncertainty: impossible for govt. to know exact effect of injection / size of multiplier.
  • Time lag: Between the increase in income and spending, people won’t spend straight away.
  • Depends on the elasticity of the supply curve (inelastic leads to big PL ↑).

Could also talk about liquidity trap theory - preference to save, rather than spend will mean no multiplier occurs.

108
Q

2.4 - National Income

What would be the effects of an inelastic supply curve on the multiplier? (Good eval using Keynesian diagram).

A

Larger increase in PL, economy has to have sufficient spare capacity, in order to minimise price level increases.

109
Q

2.4 - National Income

What would the effect of an elastic supply curve be on the multiplier?

A

Smaller increase in PL, as there is sufficient spare capacity.

110
Q

2.4 - National Income

Define multiplier effect:

A

A more than proportional increase in national income, that results from an injection of spending.

111
Q

2.4 - National Income

Define de-multiplier

A

A more than proportional decrease in national income, that results from withdrawal of spending.

112
Q

2.4 - National Income

What effects the multiplier? (WEECCR)

A
  • Wealth Effect.
  • Employment and job security.
  • Expectations of future price changes (e.g. persistent deflation).
  • Consumer Confidence.
  • Consumer credit and mortgage payments (cost / availability of).
  • Real disposable income.
113
Q

2.4 - National Income

What must be in the economy for the multiplier to have the desired effect?

A

Sufficient spare capacity.
(More spare capacity / more elastic LRAS curve, larger the effect).

114
Q

2.4 - National Income

What is the multiplier formula?

A
  • 1/1-MPC
  • 1/MPW (MPS + MPM + MPT)
115
Q

2.4 - National Income

The planned investment in the redevelopment of Dover Port will cost £115 million. The Chief Executive said it will lead to many ‘new job opportunities for local people and a transformed waterfront experiece’ with new cafés, bars and shops.

Using the example above, explain how the multiplier process leads to an incrase in aggregate demand. (4)

(2020 paper)

A
  • Knowledge/Understanding
    -> Multiplier effect is when an initial change in aggregate demand can have a greater final impact on equilibrium national income.
    -> Injection of money from investment goes round the circular flow of income, leading to a greater effect on AD.
  • Application - 115m investment. Construction workers will consume local businesses.
  • Analysis - One person’s spending money is another person’s incomes.
116
Q

2.5 - Economic Growth

Define recession

A

Two or more successive quarters of negative economic growth.

117
Q

2.5 - Economic Growth

What are the conditions of having demand-led growth with no inflation?

A

If growth is sustainable and close to long run trend rate
(Proportionate shift in AD as well, with trend rate).
There has to be sufficient spare capacity in the economy.

118
Q

2.5 - Economic Growth

How does demand-led growth affect balance of payments?

A

Tends to cause a deficit in the current account. This is because as consumer spending rises, there will be a rise in import spending.
(Especially true for UK, large MPM).

119
Q

2.5 - Economic Growth

How does demand-led growth affect the bop?

A

Less favorable, more consumption = more imports.
Inflation could make exports less competitive.

120
Q

2.5 - Economic Growth

Define export-led economic growth and give an example

A

Can be increase in economic growth without causing a current account deficit. For example, Germany has seen strong economic growth, with a current acc surplus

121
Q

2.5 - Economic Growth

How can we link macro eco growth to micro?

A

Can lead to efficiency increases for firms.
Increase DE, due to more profits.

122
Q

2.5 - Economic Growth

Give evaluations of eco growth:

A

Those who sell inferior goods (with negative YED) lose out.
Changing tech. due to inc. investment leads to disappearing markets e.g. DVD rental stores. (This is the theory of CREATIVE DESTRUCTION).
Eco growth ≠ eco development.

123
Q

2.5 - Economic Growth

What does a country want economic growth to be?

A

Sustainable and long run

124
Q

2.5 - Economic Growth

What are the types of economic growth?

A

AS-led
AD-led
(long run, short run)

125
Q

2.5 - Economic Growth

How is economic growth measured?

A

Total income
Total expenditure
Total output

126
Q

What is potential growth?

A

LR expansion of productive potential caused by an increase in AS

127
Q

2.5 - Economic Growth

What is the business cycle?

A

The stage of economic growth the economy is in.

128
Q

2.5 - Economic Growth

What are the effects of an economic boom?

A
  • High eco growth.
  • Positive output gaps.
  • Near full employment.
  • Demand-pull inflation.
  • High investment, postive expectations.
129
Q

2.5 - Economic Growth

What are the effects of a recession?

A
  • Negative output gaps
  • low inflation rates
  • Reduced tax revenue
  • Decrease in employment, incomes, output, consumption, investment, CC.
  • Increase in MPS and welfare benefit spending.
130
Q

2.5 - Economic Growth

Why does poor access to credit and banking hinder economic growth?

A
  • No way to gain loans for spending, or investment
  • People cannot save money
  • Poor families have to resort to loan sharks with punitive interest rates, leaving them in debt. Cements people in poverty.

However,
* Technology might allow people to gain access to financial systems via mobile phone instead of physical branch.
* Microfinance encourages people to take out loans for investment.

131
Q

2.5 - Economic Growth

Why does an ageing population hinder economic growth?

A
  • Output falls because more workers have to retire.
  • Puts pressure on parts of the economy that serve the elderly - health systems.
  • Workers have to pay for this - higher tax buden.
132
Q

2.5 - Economic Growth

What are booms?

A

The peak of a business cycle, when the growth is high

133
Q

2.5 - Economic Growth

What happens if we add together the UK’s booms and busts?

A

We get a structural deficit.
(More and more in debt each year).
However, this is okay if there is sufficient growth and inflation to decrease the real value of debt.

134
Q

2.5 - Economic Growth

Features of the trade cycle (4)

A
  1. Peak/boom
    -> National income is high, economy is likely working past full employment
    -> Tax revenue, consumption, investment, imports and profits are likely to be high
  2. Downturn
    -> Output and income fall leading to reduced investment and consumption, inflation tends to rise
  3. Recession
    -> At the bottom of the trade cycle -> low economic activity, high unemployment, low consumption, investment and imports
  4. Recovery/recession
    -> NI and output begin to increase and unemployment
135
Q

2.5 - Economic Growth

Benefits of economic growth (6)

A
  • Life expectancy increases
  • Generally absolute poverty decreases when economies are growing
  • Rising incomes for consumers
  • Rising tax revenues for the government
  • More finance available for the enviroment
  • Better opportunities for firms to grow
136
Q

2.5 - Economic Growth

What are the benefits of economic growth for consumers

A
  • Increased Income and Wealth: Economic growth typically leads to higher income levels and increased wealth. Example: Rapid economic growth in China has lifted millions out of poverty and into the middle class.
  • Improved Quality of Goods and Services: Higher incomes lead to greater demand for better quality goods and services. Example: Technological advancements leading to improved smartphones, healthcare, and education.
  • Greater Employment Opportunities: Growth leads to job creation, reducing unemployment rates. Example: Expansion of the technology sector has created numerous job opportunities.
  • Life expectancy increases
  • Generally absolute poverty decreases when economies are growing
137
Q

2.5 - Economic Growth

What are the costs of Economic growth for consumers

A
  • Inflation: Rapid growth can lead to inflation, eroding purchasing power. - Example: Hyperinflation in Zimbabwe in the late 2000s reduced consumer purchasing power drastically.
  • Inequality: Benefits of growth may not be evenly distributed, leading to greater income inequality. - Example: Economic growth in the U.S. has led to rising income inequality since the 1980s.
138
Q

2.5 - Economic Growth

What are the benefits of economic growth for firms

A
  • Higher Profits: Increased consumer spending boosts sales and profits. Example: Booming e-commerce has significantly increased profits for companies like Amazon.
  • Economies of Scale: Firms can expand and achieve lower costs per unit due to larger scale production. Example: Automotive industry benefits from large-scale production reducing costs per vehicle.
  • Innovation and Investment: Growth encourages firms to invest in new technologies and innovation. Example: Investment in renewable energy technologies by firms like Tesla.
139
Q

2.5 - Economic Growth

What are the negatives of economic growth for firms

A
  • Increased Competition: More firms entering the market can lead to increased competition. Example: Entry of new tech firms increases competition for established companies like Microsoft and Apple.
  • Resource Depletion: Rapid growth can lead to overuse of natural resources, increasing costs in the long term. Example: Deforestation in the Amazon due to increased agricultural and industrial activities.
140
Q

2.5 - Economic Growth

What are the benefits of economic growth for the government

A
  • Higher Tax Revenues: Economic growth increases incomes and corporate profits, leading to higher tax revenues. Example: Economic boom periods lead to increased tax collections, as seen in the late 1990s in the U.S.
  • Public Investment: Higher revenues allow for greater investment in public infrastructure and services. Example: Improved transportation networks and healthcare systems in developed countries.
141
Q

2.5 - Economic Growth

What are the costs of economic growth for the government

A
  • Inflationary Pressures: Managing inflation becomes challenging during periods of rapid growth. Example: Governments implementing tight monetary policies to curb inflation during economic booms.
  • Environmental Degradation: Economic growth can lead to pollution and environmental damage. Example: Industrial pollution in rapidly growing economies like China and India.
142
Q

2.5 - Economic Growth

What are the benefits of economic growth for current and future living standards

A
  • Improved Living Standards: Growth leads to better healthcare, education, and overall quality of life. Example: Increased life expectancy and literacy rates in countries experiencing sustained growth.
  • Technological Advancements: Innovations improve efficiency and quality of life. Example: Advancements in medical technology improving health outcomes.
143
Q

2.5 - Economic Growth

What are the costs of economic growth for current and future living standards

A
  • Environmental Sustainability: Growth can lead to environmental degradation, affecting future living standards. Example: Climate change impacts due to greenhouse gas emissions from industrial activities.
  • Resource Exhaustion: Overuse of natural resources can lead to scarcity, impacting future generations. Example: Overfishing leading to depletion of fish stocks in oceans.
144
Q

2.5 - Economic Growth

What is output gap?

A

The difference between the Actual output level and Potential output level.

145
Q

2.5 - Economic Growth

What is an negative output gap?

A

Actual level less than potential level of output.

146
Q

2.5 - Economic Growth

What is a positive output gap?

A

Actual level of output is greater than the potential level of output.

147
Q

2.5 - Economic Growth

What are the difficulties with measuring the output gap? (Consider reliability / what could change).

A
  • Difficulty estimating trends.
  • Structure of economy changes.
  • Exchange rates change.
  • Data not reliable.
148
Q

2.5 - Economic Growth

Causes of negative output gaps?

A

Underutilised resources.
Could be due to unemployment.

149
Q

2.5 - Economic Growth

Causes of positive output gaps?

A

Pushing resource use to maximum - labour working overtime, excessive use of capital.

150
Q

2.5 - Economic Growth

Positive output gap diagram?

A
151
Q

2.5 - Economic Growth

Negative output gap diagram?

A
152
Q

2.5 - Economic Growth

What are the problems with a negative output gap?

A
  • Puts downward pressure on inflation - might cause a deflationary spiral.
  • Unemployment of resources, so factors of production are not being used to their full potential.
  • Loss of potential growth, living standards, tax revenue.
153
Q

2.5 - Economic Growth

What are the problems with a positive output gap?

A
  • Resources are being pushed beyond sustainable capacity - labour and capital are being overworked.
  • Puts upward pressure on inflation.
  • Countries such as India and China, that have high inflation due to high AD are associated with positive output gaps.
154
Q

2.6 Macroeconomic objectives and policies

REBEL BELLS: (Macroeconomic objectives).

A

Regional Equality.
Economic growth. (2%)
Balanced Budget.
Environment.
Living Standards.

Balanced and stable trade.
Equality
Low unemployment (4-5%)
Low and stable inflation (2±1%)
Stability.

155
Q

2.6 Macroeconomic objectives and policies

Differences between fiscal and monetary policy:

A

Who controls - gov vs central bank.
FREQUENCY OF ADJUSTMENT:
Fiscal = yearly, monetary = monthly.

156
Q

2.6 Macroeconomic objectives and policies

What is a deflationary policy?

A

Fiscal or monetary policy aimed at reducing AD (reduced demand-pull inflation).

157
Q

2.6 Macroeconomic objectives and policies

Interest rates as a monetary policy instrument

5 effects / reasons why interest changes effect AD and its components

A
  • The rate of interest is the price at which it costs a borrower to lend from a money market
  • The rate of interest has a number of effects on AD:
  1. Consumer durables
    -> many consumers purchase durables such as kitchens and cars on credit meaning if interest is lowered it is cheaper to buy such durables and therefore demand (AD) will increase
  2. Housing market
    -> Houses are almost always bought using a mortage meaning lowered interest rates make monthly repayments cheaper
    -> Will encourage sale and purchase of property -> increased demand will result in more houses being built which is classified as increasing investment
    -> Those buying a new house / upgrading also likely to buy new furniture therefore increasing consumption
  3. Saving
    -> Increased interest results in greater interest being paid out into saver accounts meaning saving becomes more attractive relative to spending, this means less is spent into the economy reducing AD
  4. Investment
    -> Investment opportunities financed through loans will suddenly become less profitable due to a rise in interest, this means that firms will cut back or not undergo certain investment plans
  5. Ex rate
    -> Fall in interest rate will cause the exchange rate to depreciate -> more exports & less imports -> increased AD
158
Q

2.6 Macroeconomic objectives and policies

Pros and cons of demand-side policies

4 in total, generalised

A
  1. Time lags
    -> Can take significant time to see the increases in AD
    -> Especially big infastructure projects aiming to stimulate demand and employment inevitably take multiple years to construct
    -> Policies need to be focussed on increases that can be implemented quickly
  2. The national debt
    -> Increasing the deficit in order to finance expansionary fiscal policy to stimulate AD will clearly cause the national debt to increase
    ->Increases in the national debt can become problematic however in the long run dependant on whether the money was sourced internationally or domestically
  3. Rate of interest
    -> After 2008 financial crash most central banks lowered interest rates to near 0 and yet AD was not stimulated to large degrees leading to the use of QE
    -> So interest rates are of limited use
  4. Size of multiplier
    -> Disagreements about its size with classical economists arguing it being close to 0 in the short run meaning
    -> Keynesian economists argue that the multiplier can be fairly large if directed carefully eg into depressed industries that hold potential
159
Q

2.6 Macroeconomic objectives and policies

What is fiscal policy?

A

Gov. changing taxation and Gov. spending, to influence AD and eco activity.

160
Q

2.6 Macroeconomic objectives and policies

How can an expansionary fiscal policy be achieved?

A

Increase G or decrease Taxes.

161
Q

2.6 Macroeconomic objectives and policies

What does an expansionary fiscal or monetary policy aim to do?

A

Increase AD

162
Q

2.6 Macroeconomic objectives and policies

What does an contractionary fiscal policy aim?

A

Decrease AD

163
Q

2.6 Macroeconomic objectives and policies

How can a contractionary fiscal policy be achieved?

A

Decrease G or Increase Taxes
( ↓ AD)

164
Q

2.6 Macroeconomic objectives and policies

What are limitations to fiscal policy?

A
  • Time lag
  • Political costs
  • Difficulty forecasting
165
Q

2.6 Macroeconomic objectives and policies

What is monetary policy?

A

Use of interest rates + money supply (QE) to influence consumer spending + AD

166
Q

2.6 Macroeconomic objectives and policies

What are interest rates used for?

A

To control the supply of money

167
Q

2.6 Macroeconomic objectives and policies

What are the effects of higher interest rates?

A

↓ D and ↓ inflation
Or hot money flows inc. investment inc. AD in LR.

168
Q

2.6 Macroeconomic objectives and policies

What are the effects of lower interest rates?

A

↑ C ↑ Investment + ↑ Inflation

Investment increases as rate of return on investment AKA Marginal efficiency of capital (MEC) increases AS IT’S CHEAPER TO BORROW

169
Q

2.6 Macroeconomic objectives and policies

What is the role of the central banks in QE?

A
  • Create money
  • Buy bonds from banks
  • Increase money supply
170
Q

2.6 Macroeconomic objectives and policies

What is the role of banks in QE?

A
  • Banks injected with cash
  • Increase capital base
  • Reduces bond yields
171
Q

2.6 Macroeconomic objectives and policies

What is the role of borrowers during QE?

A
  • Increased supply of credit
  • Increased borrowing = increased spending
  • ↑ AD
172
Q

2.6 Macroeconomic objectives and policies

What are government bonds?

A

Used to finance national debt + gov’s public sector net borrowing requirement

173
Q

2.6 Macroeconomic objectives and policies

Who issues gov bonds? Where are they sold?

A
  • Issued by Treasury
  • Sold on bond market
174
Q

2.6 Macroeconomic objectives and policies

What is the safest type of investment?

A

Government bonds

175
Q

2.6 Macroeconomic objectives and policies

Give 3 examples of the typical markets for government bonds?

A
  • Pension funds
  • Investment trusts
  • Private individuals
176
Q

2.6 Macroeconomic objectives and policies

What will rising interest rates do to gov. bonds?

A

Rise in i makes bonds less attractive, bond prices fall.
(Inverse relationship of bond prices / interest rates). Due to bonds having a fixed i rate

177
Q

2.6 Macroeconomic objectives and policies

How does quantitative easing work?

A
  1. Central banks creates more money
  2. Uses money to buy up government bonds and corporate bonds from commercial bands and other financial institutions.
  3. Because commercial banks now have more cash, it means they can lend it to businesses and consumers.
  4. Should increase investment and consumer spending. Therefore growth.
  5. QE also leads to lower interests rates as it increases the money supply –> higher consumption and investment .
  6. To date, central bank has purchased £895bn
178
Q

2.6 Macroeconomic objectives and policies

How can QE be evaluated? quantitative easing

A
  • Banks have still been reluctant to lend
    -> Initially banks only lent to big companies as seen as less risk
    -> Government introduced funding for lending scheme (FLE) (2012)
    -> This attached conditions to QE and encouraged lending to SME’s
    -> FLE not entirely successful
  • Consumers and businesses have been reluctant to borrow
    -> Consumer and business confidence low after the financial crisis.
  • Could create inflation
    -> Quantity theory of money
    -> More money is chasing a limited number of goods.
  • Could depreciate the currency
    -> Therefore, could create imported inflation as prices of imports increase.
179
Q

2.6 Macroeconomic objectives and policies

What is discretionary fiscal policy?

A

The deliberate manipulation of government expenditure and taxation to influence the economy

180
Q

2.6 Macroeconomic objectives and policies

Examples of Supply-side policies: (IRIPI)

A
  • Increase Incentives to supply - Reduce corporation tax
  • Reform Labour market - abolish notice period
  • Improve labour force quality - ↑ Education, (increases human capital).
  • Promote competition - reduce sunk costs - breaks up monopolies.
  • Improve Infrastructure - build roads.
181
Q

2.6 Macroeconomic objectives and policies

What are the best / purest supply-side policies?

A

The ones which increase LRAS / SRAS with minimal spending.

182
Q

2.6 Macroeconomic objectives and policies

What are the different ways to classify demand-side and supply-side policies?

A

Demand-side = fiscal or monetary.
Supply-side = market-based or interventionist.
Either can be expansionary or contractionary.

183
Q

2.6 Macroeconomic objectives and policies

What does a supply side policy aim to do?

A

Improve the LR productive potential of the economy.

Pure supply-side policies achieve this with minimal government spending

184
Q

2.6 Macroeconomic objectives and policies

Market based and interventionist approaches
Define both

A
  1. Market-based policies -> aim to remove barries to efficient working of free market eg deregulation
  2. Interventionist policies -> designed to correct market failure, intervening in free market to improve efficiency directly eg state provision of education due to free market under-provision
185
Q

2.6 Macroeconomic objectives and policies

What are some main concepts for the objectives of Supply-side policies

A
  • Incentives
  • Enterprise
  • Technology
  • Mobility
  • Flexibility
  • Efficiency
186
Q

2.6 Macroeconomic objectives and policies

What are the benefits of higher productivity [6]

A
  1. Lower unit costs: Cost savings for businesses can bring lower prices, encouraging higher demand, more output and an increase in employment
  2. **Improved competitiveness and trade performance (BoP) **
  3. Higher profits: Efficiency gains are a source of larger profits for companies which might be re-invested, However not all of the profit will be reinvested. It could be payed out to shareholders
  4. Higher wages: Businesses can afford higher wages when their workers are more efficient
  5. Economic growth: If an economy can raise productivity then the trend growth of national output can pick up
  6. Mobility: Productivity improvements mean that labour can be released from one industry and be made available for another
187
Q

2.6 Macroeconomic objectives and policies

Benefits for objectives of a successful supply side policy

A
  1. Achieve a sustained improvement in the possible trade-off between inflation and unemployment (see Phillips Curve)
  2. Be more flexible in response to external demand and supply-side shocks such as rising energy prices
  3. Raise living standards through stronger long term economic growth / an increase in underlying trend rate of growth
  4. Reduce unemployment by lowering the natural rate of unemployment (less frictional & structural unemployment)
  5. Improve competitiveness in global markets and achieve a stronger balance of trade in goods and services
188
Q

2.6 Macroeconomic objectives and policies

Evaluation of Supply-side policies

A
  1. Supply-side policies have long time lags – especially when they are trying to achieve structural changes
  2. The level of aggregate demand is also important in making business investment and innovation viable
  3. Some supply-side policies (e.g. cutting higher-rate income taxes) might lead to greater inequalities of income & wealth
  4. State intervention to “pick winners” in different industries may be ineffective – there are risks of government failure
  5. Sustainability issues if policies aim to raise a country’s long term growth rate – leading to increased externalities such as pollution
  6. Supply-side policies look to achieve relative improvements e.g. In productivity – but other countries will be making gains too
189
Q

2.6 Macroeconomic objectives and policies

Examples of market-based supply-side policies

A
  • Cutting government spending (including welfare) and borrowing – forces people back to work
  • Lower business taxes to stimulate capital investment
  • Lower income taxes to improve work incentives – encourages people to get a full time job as they get more money to take home
  • Reducing red-tape to cut the costs of doing business – Getting things liscned to sell in the EU and EU and britan have different regulations
  • Improving the flexibility of the labour market including reforming employment laws and encouraging more part time work
  • Competition policies such as deregulation & anti-cartel laws
  • Privatisation of state assets – transferred to the private sector
190
Q

2.6 Macroeconomic objectives and policies

Examples of government intervention supply-side policies

A
  • State investment in public services and critical infrastructure – energy, electricity, transport and health services
  • A commitment to a minimum wage and/or living wage to improve work incentives & productivity in the labour market
  • Higher taxes on the wealthy to fund public and merit goods
  • An active regional policy to inject extra demand into under-performing areas / regions of persistently high unemployment / low per capita income – e.g. the Government’s Northern Powerhouse Project
  • Selective import controls to allow domestic industries to expand – taxes on farming goods to make uk produce more competative
  • Management of the exchange rate to improve competitiveness
  • Nationalisation of and/or stronger regulation of key industries
191
Q

2.6 Macroeconomic objectives and policies

5 conflicts between macroeconomic objectives
(inflation, econ growth, unemployment, Current account deficit, fiscal deficit)

A
  1. Inflation is too high
    -> Assume rate of inflation is too high
    -> one way to reduce inflation is to lower AD for example by lowering consumer or gov spending
    -> this is likely to lead to a recession meaing economic growth is -ve
  2. Growth is too low
    -> Assume rate of economic growth is too low
    -> can raise it with AD leading to lower unemployment and increased inflation
    -> also likely to increase incomes and therefore imports worsening the current account position (ceteris paribus) which is a conflict
  3. Unemployment too high
    -> If unemployment is too high a way of reducing it is to stimulate AD, however this may conflict with policies relating to inflation and the current account
  4. Current account is deeply in the red
    -> If imports are far greater than exports then there may be difficulties for an economy in financing this deficit
    -> cutting current account deficit by reducing domestic consumption and investment will conflict with unemployment targets
  5. Fiscal deficit too high
    -> If gov borrowing is too high a % of GDP gov may raise taxation and reduce spending
    -> such measures will inevitably conflict with unemployment objectives
192
Q

2.6 Macroeconomic objectives and policies

The short run Phillips curve - trade-off between unemployment and inflation

Desribe what the Phillips curve shows and why.

A
  • One example of conflicting macroeconomic objectives
  • Describes the statistical relationship between the rate of employment and the rate of change of money wages (Phillps curve) Money wages are the most important cost to producers
  • When wage rates increase faster than productivity
    -> costs increase for firms
    -> they therefore increase their prices
The Phillips curve shows the trade-off between unemployment and inflation. The lower the rate of unemployment the higher the rate of inflation
193
Q

2.6 Macroeconomic objectives and policies

3 conflicts and trade-offs between economic policie

A
  1. Changes in interest rates
    -> Gov may use interest rates to influence AD and therefore inflation and unemployment in the short term
    -> however persistently high interest rates will damage long term investment and hence long term growth
    -> will also likely raise the value of the currency leading to a worsening of the current account
  2. Supply-side policies
    -> Supply-side policies should increase the productive potential of an economy leading to a shift in LRAS and therefore a reduction in inflation in the long run
    -> However -> policies that encourage investment in physical capital will lead to higher AD in the short term and therefore increase inflationary pressures
  3. Fiscal deficits
    -> Countries which have fiscal deficits that are too high may attempt to reduce this by cutting gov spending and raising taxes -> will lead to higher unemployment and lower growth in the short term
194
Q

What is an evaluation to crowding out?

A

When there is spare capacity, govt. spending could lead to ‘crowding in’, as spending is facilitated through the multiplier.

Crowding out doesn’t occur in a liqudity trap / when secular stagnation theory is present.

195
Q

What is crowding in?

A

When higher govt. spending leads to larger private sector investment.

196
Q

What is crowding out?

A

When higher government spending, financed by borrowing causes a reduction in private sector investment.

197
Q

What are the two ways in which crowding out lessens private sector investment?

A
  • More govt. borrowing = more sales of govt. bonds = individuals have less to spend on investment.
  • More govt. borrowing = increased interest rates = lower MEC (expected rate of return) on private sector investment.
198
Q

How can expansionary fiscal policy cause crowding in by the positive multiplier effect?

A

Induced saving, due to larger eco growth (H-D model).

199
Q

How can crowding in occur when there is inflation?

A

Inflation characterised by high interest rates. Govt. spending G. will lessen real interest rates (Loanable funds theory).
(Encouraging private sector investment).
(Inflation also reduces the real value of interest rates).

200
Q

How do we evaluate the ‘crowding in’ effect during times of deflation?

A

This is only useful if interest rates are low and ‘sticky’ i.e. liquidity trap.

(During times of deflation, real interest rates are increase, due to fisher equation: real i = nominal i - inflation).

201
Q

How do we represent the crowding in effect on a diagram?

A

It is simply the same as the positive multiplier effect:

202
Q

Give the crowding out diagram (resources):

A
203
Q

What is the ‘brain drain’ argument for progressive taxes?

A

Human capital flight due to excessively high top rate of tax.

204
Q

Give the laffer curve diagram:

A
205
Q

What is Ricardian equivalence theory?

A

Idea tax cuts financed by govt. borrowing doesn’t change consumption as consumers anticipate future tax increase.

206
Q

What does Ricardian equivalence assume?

A

hat consumers are rational and realise future taxes will have to rise.
Life-cycle hypothesis - consumers want to smooth their consumption over their lifetime.

207
Q

Give an example of how life-cycle hypothesis applies to tax rise:

A

Consumers want to smooth consumption over life time.
Therefore will save following a tax cut in anticipation to pay future tax rise.
(Life-cycle hypothesis is an assumption in the Ricardian theory of equivalence).

208
Q

Give the influence of tax cuts under Ricardian equivalence diagram:

A
(However, no net increase in disposable income overall)
209
Q

Describe the Ricardian equivalence diagram

A

If tax cuts, increase disposable income in the short-term, then it reduces disposable income in the long-term (due to expectations of future tax rises). Therefore, a rational consumer believes their lifetime income is unchanged by a tax-cut.

210
Q

Give the evaluation diagram to Ricardian equivalence: (Hint economy has to be in recession)!

A

Spare capacity, so tax cuts incentivise use of spare capacity - (private sector saving). This is crowding in.

211
Q

What is the poverty trap theory?

A

If taxes are high, there is little incentive for workers to work and give up benefits.

A Level Economics - Edexcel (18 decks)

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