Theme 2 (MDF) Flashcards
Structure for 25 marker
KAAE x 2
conclusion
Trade cycle axis
Y real GDP
X time
Why do some consumers not want the most efficient form of production?
It may involve cruelty to animals or damage to the environment.
Why may claimant count differ from ILO’s measure of unemployment?
Because the ILO measures 16-18 year olds but claimant count doesn’t.
Who does the claimant count exclude?
People under 18, people in full-time education, people not eligible for contribution based JSA, people with high savings, people on a government training scheme.
Effects of an outward shift in SRAS on the economy
Lower prices - more output - more labour
Lower prices - more exports - surplus
Disadvantages of export-led growth
Susceptible to shock, exchange rate risks.
How does spare capacity affect the multiplier?
If there is hardly any spare capacity, firms will struggle to.
What is the crowding out effect?
Crowding out occurs when government spending pushes up demand for the factors of production which then increases their price. This may decrease private sector investment.
What is a white elephant project?
Projects that are poorly constructed without adequate cost-benefit analysis.
What is consumer credit?
The use of credit for personal needs (except a home mortgage).
Evaluation that investment won’t lead to an increase in potential output
If the investment is only to increase depreciation.
What is a base year?
Year serving as point of comparison for other years in a price index or other statistical measure.
What are animal spirits?
Keynes - Business confidence: the mood of managers and owners of firms about the future of their industry and the wider economy.
Evaluation that investment may not cause economic growth
Keynes - ‘naive optimism’ where entrepreneurs are encouraged by a rising market and take too many risks.
Is national wellbeing and GDP per capita linked?
To some extent - Easterlin paradox. National wellbeing is assessed by examining a range of factors such as health, personal relationships, and employment.
Formula for Real GDP
% change in nominal GDP / original GDP - inflation.
How to calculate CPI?
- Fix the basket based off of family expenditure survey LCF
- Find the prices and assign weights to each item based on the % of income
- Calculate the basket’s cost by multiplying the weights and prices and adding them
- Choose a base year and calculate the index
- Calculate the inflation rate each month.
What is an index number?
A number showing the variation in a price or value compared with the price or value at a specified earlier time.
Where do they get the data for CPI?
7000 households, then they find 700 goods.
Formula for AD
AD = C + I + G + (X-M).
How to calculate the inflation rate?
CPI this year - CPI last year / CPI last year x 100.
What is the international trade effect?
Occurs when a change in the price level leads to a change in the quantity of net exports demanded.
Example of how economic performance of other economies affects the trade balance of the UK
Slow growth of the Eurozone in 2012 to 2014 affected the UK’s export sales.
Formula for gross investment
Net investment + depreciation.
GDP to compare living standards
- GDP per capita is better
- Doesn’t include subsistence economies or hidden ones
- Internationally recognized
- Doesn’t show what governments are spending money on
- Doesn’t highlight what goods are being produced.
Definition of wealth
A person’s total value of all their assets.
Definition of income
Flow of money received.
Why may banks give out more money if the price of your house has risen?
It acts as a collateral asset so you appear more trustworthy.
Formula for net investment
Gross investment - depreciation.
What is labour productivity?
Output per time period / number of employees.
Factors influencing SRAS
- Changes in costs of raw materials and energy
- Changes in exchange rates
- Changes in tax rates
- Changes in tax on imports.
Factors influencing LRAS
- Technological advances
- Changes in relative productivity
- Changes in education and skills
- Changes in government regulations
- Demographic changes and migration
- Competition policy
- Minimum wage.
How many work visas were issued in 2023?
Just under 500,000!
Keynesian LRAS
At low levels of economic activity LRAS = elastic. Towards full employment - output at max - LRAS = inelastic.
Neoclassical LRAS
In the long run if the price level changes there will be no increase in output as it is assumed the economy is working at full potential.
Why is SRAS upward sloping?
- Contracts make some wages and prices ‘sticky’
- Firms are often slow to adjust wages
- Menu costs make some prices sticky
- All industry supply curves added together are upward sloping.
Trends of a recession
2 periods of consecutive negative economic growth, high unemployment, less consumption, firms going out of business.
Why may a country’s GNI be inaccurate?
- GNI usually misses out informal employment, which can account for a large proportion of national income.
Why may a country’s GDP be higher than another’s but its GDP per capita is lower?
It may have a larger population.
What is PPP (Purchasing Power Parity)?
PPP (Purchasing Power Parity) is the number used by the World Bank. It measures the value of a country’s money in relation to what can be purchased with that amount.
How does deflation affect PPP?
Increases it as each unit of currency can buy more than before.
Purchasing power parity calculation
Find a basket of goods in each country and compare the price needed to purchase each basket.
Why use PPP?
To improve accuracy when comparing data between countries.
Limitations of using GDP to compare living standards
- Difference in population
- Different inflation rates
- Different exchange rates
- Different income distribution
- Different expenditure from the government.
Causes of unemployment
Demand-deficiency from slow growth or falling incomes, occupational immobility, geographical immobility, imperfect information, seasonal, frictional, structural unemployment, real wage inflexibility.
How to calculate unemployment?
ILO survey, claimant count.
Advantage and disadvantage of ILO survey
Advantage - used internationally, so easy to make comparisons between countries. Disadvantage - can have expensive administration costs and only surveys 6000 households.
Advantage and disadvantage of Claimant Count?
Advantage - it is easy to measure as it is just the number of people claiming it. Disadvantage - stigma associated with it and it won’t measure those who are not eligible to claim it but are unemployed.
ILO Labour Force Survey
Out of work for 4 weeks, ready to start within 2 weeks. Age of 16 or above.
Limitation of labour force survey
Only surveys 80,000 households.
Limitation of claimant count
‘Stigma’ means people don’t want to claim + they have to fill out forms at the job centre.
How to find unemployment rate?
Unemployed / active x 100.
Can you have a LONG RUN output gap on neoclassical?
No, need SRAS curve to show working overtime.
What do classical economists believe about long-run markets?
In the long run, all markets will clear and the economy will return to maximum potential output.
What happens to real output in the long run if AD increases?
Nothing, just inflation.
How do you find the employment rate?
Number of those in work divided by the population of working age expressed as a percentage.
Why may the government value happiness more than economic growth?
Happiness includes quality of life rather than income alone.
What is the Easterlin Paradox?
High incomes correlate with happiness, but increased income doesn’t correlate with increased happiness long-term.
How does the government find the happiness of its people?
Through the Office for National Statistics national well-being survey.
What is the difference between deflation and disinflation?
Deflation is a sustained fall in the general price level; disinflation is a sustained fall in the rate at which the general price level is rising.
What is the formula for CPI?
Change in index / original index x 100.
What if CPI decreases?
What is an argument against the wealth effect?
In the UK, only 50% of homeowners own their house; the other 50% are renting or saving.
What is the wealth effect in America?
6% - Ricardo Sousa.
What is the wealth effect in Europe?
0% - Ricardo Sousa.
What is the real balances effect?
When a price increases, buying power decreases, causing less purchasing.
By how much did the world’s output decrease following the Great Depression?
50%.
What does GNI stand for?
Gross National Income.
What is GDP?
Gross Domestic Product - total market value of all final goods and services produced annually in an economy.
What does GNP measure?
Total market value of all goods and services produced by domestic residents + income from abroad - income claimed by non-residents.
What is the difference between GDP and GNI?
GDP measures production; GNI measures income.
What are limitations of using CPI to find the rate of inflation?
- Does not include housing costs
- Some people do not have representative spending habits
- List of 700 is only changed once a year
- Some households may not provide accurate information
- Doesn’t include mortgages
- Time lags
- Doesn’t include changes in quality
- One item’s fluctuation can affect the whole valuation.
Why can changes in quality be a problem when using CPI?
An increase in prices may be due to an improvement in quality, not inflation.
How is CPI and CPIH different?
CPIH measures housing costs and council tax.
What happens when long-run aggregate supply increases?
An increase in potential growth.
What is collateral?
Something pledged as security for repayment of a loan.
How does aggregate supply increase if imports get cheaper?
Cheaper imports create downward pressure on domestic prices, leading to lower prices from domestic producers.
What are excise duties?
Levies on demerit goods such as alcohol, tobacco, petrol, and gambling.
How do increasing interest rates lead to more expensive exports?
Countries begin to save in the UK, appreciating the currency, making exports more expensive.
What is the RPI?
Retail Price Index - shows the rate of change of prices in everyday life.
Is income tax progressive?
Yes, the richer you get, the more tax you pay.
What is fiscal drag?
Increasing fiscal drag means income tax is becoming more regressive.
How is indirect tax regressive?
As incomes increase, tax paid as a % of income decreases; as incomes decrease, tax paid as a % of income increases.
What is a current account?
Measures international trade in goods and services, investment income, and net transfer payments.
What is a current account surplus?
When a country exports more than it imports.
What are causes of surpluses on the current account?
- Low economic growth
- Low inflation rates compared to elsewhere
- Low value of currency compared to elsewhere
- Low wage costs.
What is a current account deficit?
When a country imports more than it exports.
What are causes of current account deficit?
- High economic growth
- High inflation rates compared to elsewhere
- High value of currency compared to elsewhere
- High wage costs.
What is the difference between RPI and CPI?
RPI includes VAT, other taxes, and mortgage interest payments, while CPI excludes these.
What are uses of CPI and RPI?
- Measure difference in UK’s international competitiveness
- Inform government spending on welfare benefits or state pensions.
What is inflation?
A sustained increase in the general price level.
What is the inflation rate?
The percentage change in the price index from the preceding period.
What are causes of deflation?
- Decrease AD
- Increase AS.
What are impacts of inflation on consumers?
- Fall in real wages
- Value of savings decreases if inflation outweighs interest rates.
What are the two measures of inflation?
- CPI - consumer price index
- RPI - retail price index.
What is CPI?
A measure of the overall cost of goods and services bought by a typical consumer.
What is CPI used for?
Monitor changes in the cost of living over time.
What is RPI?
Retail Price Index - shows the rate of change of prices in everyday life.
How is RPI calculated?
Based on Living Costs and Food surveys from 6000 households, including mortgages.
What is RPI used for?
To make monetary policy decisions.
What is core inflation?
CPI minus food and energy costs.
When is inflation bad for savers?
If it is larger than interest rates, savings lose real value.
Why is inflation bad for those on fixed incomes?
Inflation implies their incomes will fall in real terms.
What are effects of inflation on firms?
- Raw material costs rise, profit margins fall
- Staff may demand a raise, increasing production costs
- Increased imports, lowering UK firm’s profits
- Less investment due to uncertainty.
What are effects of inflation on government?
- National debt improves
- Balance of trade worsens
- Increased inequality ( effects poorer people more)
What are effects of inflation on workers?
- Those on fixed incomes suffer (EVAL: commission workers benefit)
- Unemployment may occur due to lack of investment.
- Decreased motivation if real wages are falling.
What is job seeker’s allowance?
A benefit paid by the government to those unemployed and trying to find a job.
What is the employment activity rate?
Proportion of the working age population (16 to 64) who are active or potentially active members of the labour market.
What is universal credit?
Single monthly benefit for people on low income or out of work.
What is the effect of migration on the economy?
- Increased employment
- Possible increased unemployment
- Remittances
- They will pay tax.
What is the effect of unemployment on consumers?
- Decreased consumption
- Decreased confidence
- Mental illness.
- decreased wealth
- decreased house prices
What is the effect of unemployment on firms?
- Fall in demand for goods and services (lose output).
- Bigger pool of labor force to choose from.
- Less pressure for higher wages.
- Less risk of strikes as employees may fear they will be replaced.
What is the effect of unemployment on workers?
- Decreased skills.
- Decreased income.
- Lower living standards.
- Difficulty getting a job in the future.
What is the effect of unemployment on government?
- More spending on benefits.
- Less tax revenue.
- Increased inequality.
- possibly more increased crime.
- opportunity cost.
What is the effect of unemployment on the economy?
- Lost output - real GDP will fall
- reduced tax revenue for the government
- increased burden on taxpayers to fund benefits and training measures
- increased burden on the healthcare system
- increased crime.
What is monetarism?
The belief that inflation occurs when too much money is chasing too few goods.
When is inflation good for a firm?
If it is caused by an increase in demand (signals there is profit to be made).
Why are weights used to calculate CPI?
Because it is more important to use goods that are most important in a consumer’s expenditure.
Why may CPI not be representative for a pensioner?
They will not be spending money on similar goods (they may spend more on heating and food).
What is demand-pull inflation?
When AD increases faster than AS.
What is the price wage-inflationary spiral?
The rapid increase in average price level resulting from demand-pull inflation leading to negotiation of higher wages, causing cost-push inflation.
What is the formula for real wage?
Nominal wage/CPI x 100.
What is a deflationary spiral?
The spiral begins with deflation, where there is a sustained fall in the general price level, leading consumers to delay purchases, reducing AD, and causing further price falls.
What are 3 benefits and consequences of high inflation?
Benefits: protects economy from deflationary spiral, real value of debt decreases, decreases real wages. Consequences: inflationary spiral could lead to hyperinflation, decreases real value of savings, may decrease investment due to uncertainty.
What factors affect the rate of growth of wages?
Relative bargaining power of trade unions, derived demand from economic growth, changes in productivity of labour, elasticities of supply and demand of labour, government policy.
What is cost-push inflation?
Period of inflation caused by upward shift in aggregate supply leading to rising prices and falling output.
What are problems with CPI?
Substitution bias, introduction of new goods, unmeasured quality change.
What is menu cost?
The cost to firms of changing prices.
What are shoe leather costs?
The increased costs of transactions caused by inflation.
What is loss of purchasing power?
Occurs because inflation causes the value of the individual dollar to decrease over time.
What is wealth redistribution?
Surprise inflation redistributes wealth between borrowers and lenders.
What is substitution bias?
Consumers may change their purchasing habits away from goods that have increased in price.
What is unmeasured quality change?
Improvements in the quality of goods in the basket increase the value of each dollar.
What is CPI?
Consumer Price Index - a measure of the overall cost of the goods and services bought by a typical consumer.
What are surpluses on a graph?
Consumer surplus above the line, producer surplus below the line.
What is the long-term impact of a positive output gap following the rise of wages and costs?
Inflationary pressures.
What is the difference between disinflation and deflation?
Disinflation is a decrease in inflation, while deflation is when inflation is negative.
What is a disadvantage of increasing corporation tax?
Depreciates capital value, leading to decreased investment and lower productivity.
What is the definition of ‘claimant count’?
Number of people claiming unemployment benefits.
Why would demand for train tickets increase due to petrol prices?
If petrol is expensive, cars are a close substitute, leading to a large response in demand for train tickets.
What are the features of a positive output gap?
Actual output higher than potential output, workers paid overtime, inflationary pressure.
What are the features of a negative output gap?
Actual output lower than potential output, unemployment, spare capacity, workers are slacking.
What is the circular flow equation?
National income = national expenditure = national output.
What is the effect of an increase in employment on the circular flow of income?
More employment leads to more money flowing from firms to workers, rising incomes, increased consumption, and profit for firms is invested.
What is the monetary cost?
What you pay.
What is the multiplier ratio?
The increase in GDP following an initial injection into the economy.
What is the components share of aggregate demand?
Consumption = 60%, Investment = 14%, Government Spending = 25%, Exports minus Imports = 1%.
What percentage of government spending is on the NHS?
20%.
What percentage of government spending is on social support?
40%.
What are the causes of economic growth on the AD side?
Increase consumption, increase investment, increase government spending, increase exports.
What are the causes of economic growth on the AS side?
Increased investment, supply-side policies, new technology, looser immigration policies.
What is actual growth?
Economic growth as measured by recorded changes in real GDP over time.
How is actual growth measured?
By adding up the income, spending, and output of a country.
What is potential growth?
Shows how much a country would produce if there was full employment of all resources.
How is potential growth measured?
By the potential size of the labour force, capital stock, productivity, and discovery of natural resources.
What are 3 consequences of economic growth?
Environmental degradation, wealth and income inequality worsens, inflation.
What are 3 benefits of economic growth?
Increased standard of living, increased life expectancy, higher tax revenue.
What is a positive output gap?
The level of actual real output in the economy is greater than the trend output level.
What is a negative output gap?
The level of actual real output in the economy is lower than the trend output level.
What are benefits?
Payments from the government to low income workers or the unemployed.
Explain one disadvantage and one advantage of increasing benefits.
Advantage: Workers have more disposable income, increasing consumption. Disadvantage: Little incentive to work, leading to more unemployment.
What are merit goods?
Goods which should not be denied to people who cannot pay for them.
What does a competitive market look like?
Large number of firms, low barrier of entry.
What are characteristics of a boom?
High rates of economic growth, near full capacity, near full employment, demand-pull inflation.
What are characteristics of a recession?
Businesses produce less, unemployment increases, low rate of inflation.
What is monetary policy?
When central banks control the base interest rates and money supply to influence aggregate demand.
What are transmission mechanisms of monetary policy?
The ways in which monetary policy affects aggregate demand and the economy.
What is the wealth effect?
When the price level rises, people feel wealthier and consume more.
What is the downward multiplier effect?
Increase in withdrawals leads to a larger decrease in aggregate demand.
What are macroeconomic objectives?
To increase the standard of living.
What does ‘all markets will clear’ mean?
All resources are used and wages can move up and down.
What are 3 possible changes to the cost of production?
Cost of raw materials, productivity, wages.
What do movements along the AS curve cause changes to?
The price level.
What causes shifts to the AS curve?
Changes to the cost of production.
What is the formula for the multiplier effect?
1/(1-MPC).
What is the formula for RGDP?
Expenditure = income = output.
What are 5 macroeconomic objectives?
Low unemployment, inflation around 2%, economic growth, balanced trade, low inequality.
Why do we want 2% inflation?
Stability allows firms to predict future costs and prices.
What is occupational immobility?
When workers can’t move between different jobs due to lack of skills.
How can the government intervene to solve occupational immobility?
Through education, training, and apprenticeships.
What is geographical immobility?
The inability of workers to move from one job in a particular area to another.
How can the government improve geographical immobility?
By providing relocation subsidies and transport improvements.
What is the exchange rate definition?
The price of one currency in terms of another.
What is inequality?
The difference in living standards between the rich and the poor.
What is inequality?
The difference in living standards between the rich and the poor.
How does inflation affect the balance of payments?
If country A has worse inflation than country B, then consumers will buy from country B, improving its current account.
How do changes in national incomes affect the balance of payments?
As income increases, spending on normal goods increases. If more normal goods are imported, import expenditure will increase and the current account will decrease.
How does the quality of goods supplied affect the current account?
A country that produces lower quality exports will sell less, causing export revenue to decrease and the current account to decrease.
How do costs of production affect the balance of payments?
If costs of production are higher in country A, then the product will be more expensive than in country B, leading to decreased export revenue.
How does quality affect the balance of payments?
If goods are of higher quality in one country than another, export revenue will increase.
Why do we want balanced trade?
By reducing a current account deficit, the capital & financial account surplus will be smaller, leading to less foreign investment and less future earnings leaking out of the economy.
What are the 3 firm objectives?
- More market share (can charge more as a monopoly)
- Doing some good (moral)
- Maximise profit
What are the government’s objectives?
‘The public’s interest.’
What is fiscal policy?
The policy that controls the level of government spending and tax.
What do firms give in return for factors of production?
Factor incomes (wages and rent).
What is the formula for the accelerator effect?
It = a(Yt - Yt-1).
What does the demand curve represent?
Price on the Y axis and quantity on the X axis, sloping from top to bottom constantly.
Why is the demand curve downward sloping?
Due to the law of diminishing marginal utility.
What is the real balance effect?
An increase in the price level reduces the purchasing power of households.
What are the injections in the circular flow of income diagram?
Government spending, investment, exports.
What are the leakages in the circular flow of income diagram?
Savings, imports, taxes.
What do firms provide to households in the circular flow of income?
Goods and services, factor incomes.
What do households provide to firms in the circular flow of income?
Spending, factors of production.
What are the factors of production?
Land, labor, capital, entrepreneurship.
What percentage of consumption is in AD?
60%.
What percentage of investment is in AD?
14%.
What percentage of government spending is in AD?
20%.
What percentage of (X-M) is in AD?
1%.
What is the definition of aggregate demand?
Total amount of UK goods/services demanded at a given price level.
What is RGDP?
Measures the value of an economy’s national output, adjusted for inflation.
What is the definition of unemployment?
People of working age who are without work, available for work, and actively seeking employment.
How could spending on infrastructure improve the balance of payments?
It could reduce costs so exports appear more competitive.
What is the working age population?
The number of people aged 16-64 who are not in jail, hospital, or some other institution.
What is the definition of inactive?
Not seeking work or not able to work.
What is the definition of being underemployed?
When a worker requires a more skilled job or more hours.
Underemployment increased by 47% after the financial crisis.
What does SPICEE stand for?
Strong pound imports cheap, exports expensive.
What does WPIEEC stand for?
Weak pound imports expensive, exports cheap.
What are the 5 types of unemployment?
Frictional, structural, cyclical, seasonal, real-wage unemployment.
What are the 2 measures of unemployment?
Labour force survey, claimant count rate.
How many people answer the labour force survey and how often is it conducted?
60,000, once a year.
What are the downsides of the labour force survey?
- Small sample size
- It only takes place once a year
- People can lie.
Why do some people not claim the claimant count?
- They may have savings or sufficient income
- Bureaucracy (excessively complicated administrative procedure)
- Stigma
- Hidden employed.
‘All labour is derived demand’ - what does it mean?
The demand for a service comes from the demand for the good that it provides.
What is real wage unemployment?
When wages are set above the equilibrium level, causing the supply of labour to be greater than demand.
What does the real wage unemployment diagram show?
Excess supply of labour because wage is above equilibrium due to national minimum wage or trade unions.
What is frictional unemployment?
The unemployment which exists in any economy due to people being in the process of moving from one job to another.
What is seasonal unemployment?
Workers who do not work year-round because of the nature of their jobs.
What is cyclical unemployment?
Unemployment caused by the lack of jobs during a recession.
What is structural unemployment?
A worker’s job skills do not match those necessary to get a job, requiring education or training due to occupational or geographical immobility.
What is moral hazard?
Arises when people behave recklessly because they know they will be saved if things go wrong.
What is adverse selection?
The problem of incomplete information - of choosing alternatives without fully knowing the details of available options.
When the price level increases, what happens to aggregate demand?
It causes a contraction (as RGDP decreases).
When the price level decreases, what happens to aggregate demand?
It causes an extension (as RGDP increases).
Why is the AD curve downward sloping?
Due to the real balances effect, interest rate effect, and foreign trade effect.
What is the foreign trade effect?
At higher prices, an economy is less likely to export and more likely to import, resulting in lower overall AD.
What are contractions and extensions in the context of AD?
Movements.
What is the formula for APC?
Consumption/income.
What is the formula for MPC?
Change in consumption/change in income.
What are the 4 functions of money?
- Medium of exchange
- Unit of account
- Store of value
- Standard of deferred payment.
What are the 5 factors influencing investment?
- Confidence
- Tax
- Spare capacity goes down, investment goes up
- Availability of credit
- Growth of demand.
What happens when there is a higher demand at each price level?
There is an outward shift.
What is the formula for disposable income?
C + S = Y.
Money left over after direct taxes and after any transfer payments have been received.
What is hidden unemployment?
Unemployment of potential workers that is not reflected in official unemployment statistics, due to the way the statistics are collected.
What are examples of hidden unemployment?
- Part-time workers
- Discouraged workers
- Over-skilled workers.
What are dividends?
A sum of money paid regularly by a company to its shareholders out of its profits based on the shares that they hold.
What is primary income?
Net flow of income from domestic factors of production abroad, e.g., dividends on foreign investment and from profit, interest, and dividends.
What are 3 examples of primary income?
- Profit
- Interest
- Dividends.
What is secondary income?
Transfer payments - the money transferred from one thing to another without any economic impacts.
What are 3 examples of secondary income?
- Foreign aid
- EU budget
- Remittances.
What are the 5 factors influencing the current account?
- International competitiveness
- Economic growth of the UK
- Economic growth of trading partners
- Exchange rates
- Protectionism.
What are the 3 parts of the balance of payments?
The current account, capital account, financial account.
Why do we need a balanced current account?
For sustainable growth and economic stability.
What is the capital account?
National account that records transactions involving the purchase and sale of assets.
What are the components of the capital account?
Capital transfers, transactions in non-produced, non-financial assets.
What is the current account?
In the balance of payments, it records transactions involving the export or import of goods and services.
What is the financial account?
The part of the balance of payments that records purchases of assets a country has made abroad and foreign purchases of assets in the country.
What are the components of the financial account?
Direct investment, portfolio investment, reserve assets.
What are remittances?
Transfer of money from a foreign worker to their home country.
What might influence secondary income?
- External shock
- How much migration/immigration (impacts remittances).
What is a credit item?
An inflow to the current account balance.
What is the ‘invisible balance’ regarding the current account?
Services or other products which are not physically transferred.
What are 4 causes of a current account deficit?
- Economic growth
- SPICEE
- Fall in international competitiveness
- Low growth of trading partners.
Why may there be a fall in international competitiveness?
- High relative inflation
- Low quality
- Lack of productivity.
When are current account deficits not an issue?
- If they are short term
- If the imports are capital goods
- If it is a small % of GDP.
When are current account deficits an issue?
- Sign of supply-side issues
- Continues in the long run
- Short run growth issues.
What are the 4 sections of the current account?
Trade in goods, trade in services, primary income, secondary income.
What is a floating exchange rate?
A monetary system in which exchange rates are allowed to change according to their market prices.
How do rising exchange rates help governments pursue low inflation?
The price of imports falls.
Why does AD shift inwards when there is a current account deficit?
Because the (X-M) sector of the AD equation is larger, so AD decreases.
What are the consequences of a deficit?
- Inward shift in AD
- Fall in output
- Disinflation
- Increased unemployment.
What are policies to reduce a deficit?
- Subsidise domestic production
- Increase protectionism
- Devaluation of the pound.
What are ways to reduce expenditure?
- Contractionary monetary policy
- Contractionary fiscal policy.
What are hot money flows?
When you take advantage of other country’s interest rates and exchange your currency for theirs (this can cause appreciation)
What are the 3 levers to monetary policy?
Interest rates, money supply, exchange rates (not used by the UK)
Why does the UK not use the exchange rate lever?
In order to maintain interest rate sovereignty
What is the interest rate Transmission mechanism?
How changes to the I.R work through the economy
What is the BoE base rate?
The rate of interest charged by the BoE to banks to borrow money (4%)
What happens when Base interest rate decreases?
- Market rate decreases
- Asset prices increase, cheaper mortgages –> increases demand, increased price level
- Expectations rise and confidence increases
- Exchange rate decreases
- More investment (cost of borrowing decreases -> firms are now more incentivised to invest)
What are the limitations of changing interest rates?
- Time Lags 1.5-2 years
- Offset by fiscal policy
- State of the economy (confidence levels)
Who is the current Chancellor of the Exchequer?
Jeremy Hunt
What is a budget deficit?
That is when a government spends more than they collect in taxes for a certain time period.
What is the national debt?
The total amount of money that a country’s government has borrowed, by various means.
What is the government deficit?
Government expenditures exceed revenues
What is personal allowance?
A certain amount of money that they can earn before they pay income tax
What is a progressive tax?
More you earn, the more you pay
What are the advantages of a progressive tax?
- Increase AD due to consumption as people with lower incomes have larger MPCs
- If it increases then there will be an increase in tax revenue as the rich are paying more
- Income can be redistributed from the wealthy to the poorer
- Reduces tax burden for low income families
What are the disadvantages of progressive tax?
- Brain drain (they move to countries with lower tax rates, laffer curve)
- Reduced work incentives for those earning high incomes. These are the people that the UK needs as they are productive and skilled
What is a regressive tax?
Less you earn the more you pay
What is a proportional tax?
A tax in which the average tax rate is the same at all income levels.
What is a structural budget deficit?
Persists over the course of an economic cycle
How many consecutive months of negative economic growth are required to label an economy as being in a recession?
2 quarters of 3 months (6 months)
What is the x-axis for the trade cycle?
Time
What is the y-axis for the trade cycle?
Real GDP
What are the 4 sections of the trade cycle?
Boom, bust, slump, recovery
What are 2 limitations of monetary policy?
- Money supply –> time lags
- Fiscal policy can counteract it
How does increasing interest rates affect the exchange rate?
They increase (pound appreciates) because people want to put their money into UK banks, meaning the demand for the pound increases
What is the impact of decreasing interest rates on investment?
Low interest rates incentivise borrowing and investment because it actually lowers the risk of investment to firms. If the cost of borrowing is less, firms now need to make a lower rate of return of their investment to cover the cost of the loan and make a profit
What are 2 limitations of fiscal policy?
- Monetary policy counteracts it
- Causes large fiscal deficits –> national debt
What are the limitations of demand-side policies?
- Time lags (transmission mechanism)
- Depends on spare capacity
- Depends on the size of the multipliers
- Increased national debt
What are the issues with having a large national debt?
- You have to increase taxes to pay it off
- Government may be declined other loans
- Will lead to large and structural problems
What is the definition of balance of payments (account)?
The difference between the flow of money into and out of a country(‘s economy)
What are the sections of the balance of payments?
Current account, financial account, capital account
What is a demand-side policy?
Are attempts to increase or decrease aggregate demand to affect output, employment, and inflation
Why should government give independence to central banks?
- Less corruption and political influence
- Less regulatory capture
- Reduces policy myopia (where you seek solutions to short term problems rather than long term)
- Economic policies won’t be influenced by upcoming elections etc.
- High turnover of chancellors so if it was independent, the UK would have consistent policies
What is quantitative easing?
The introduction of new money into the money supply by a central bank.
How does QE work?
- The Central Bank creates money electronically. (This is a similar effect to printing money, except they are increasing bank reserves which don’t need to be printed in the form of cash)
- Commercial banks have more money, public then borrow and spend newly created money which increases AD
What is the opposite of QE?
Sale of government bonds to banks. This reduces the liquidity of banks and means they have less money to loan
What is an evaluation of QE?
Liquidity trap - where interest rates are so low that you can’t lower them any further
What are examples of demand-side policies?
Fiscal policy-cutting taxes, monetary-raising interest rates, quantitative easing, devaluation-reduce in value of currency
In 2016, the government taxed 1% of the highest bracket of earners. What overall % of tax revenue did these people make up?
27%
What is the definition for the base interest rate?
The rate at which they will lend money to high street banks.
What is a supply-side policy?
Increase or decrease the productive capacity of the economy
In the trade cycle, what is each line labelled as?
Straight line = actual GDP, curve = potential trend GDP
Will government spending on benefits increase AD?
No, they are transfer payments
What is a counter argument to monetary policy reducing inflation (pensioners)?
Pensioners rely on returns on savings so if IR go up then they will consume more leading to more inflation (1 in 6 people in UK are pensioners)
What was the US response to the Great Depression?
Gov spending, tariffs, low interest rates, increased money supply
What was the UK response to the Great Depression?
Initially: tariffs, increased tax, cut wages. Then: abandoned gold standard -> exchange rate of pound fell by 25% -> improved international competitiveness, lowered interest rates
What was the interest rate in America during the Great Depression?
0%
What was the US response to the 2008 financial crisis?
Government spending: Economic Stimulus Act led to $787 billion bill spent over several years, lowered IR, QE increased money supply by $3 trillion (economists still debate how effective this really was)
What was the UK response to the 2008 financial crisis?
£20 billion Small Enterprise Loan Guarantee scheme, 2.5% cut in VAT, cut base rate 5 TIMES during 2008 ALONE before hitting a historic low of 0.5% in 2009, Government purchased £375 billion in assets (QE)
Explain one advantage and one disadvantage of raising the income tax rate for high earners.
Advantage - More tax revenue –> more gov spending –> multiplier effect –> increase aggregate demand
Disadvantage - Decrease disposable income –> decrease consumption –> decrease aggregate demand
How to shift LRAS?
Increase in quantity or quality of FoPs
What are market-based policies?
Provide incentives so that private decision makers will choose to solve the problem on their own
What are interventionist supply-side policies?
Any policy based on government intervention in the market intended to affect the supply-side of the economy, usually to shift the LRAS curve to the right, increase potential output and achieve long term economic growth.
What are 4 examples of interventionist policies?
- Government spending on education / training
- Government spending on healthcare
- Government spending on infrastructure
- Policies to reduce geographical immobility of labour
- Stricter competition policy
What are examples of market-based supply-side policies?
• Cutting government spending on benefits and cutting direct taxes
• Laws to control trade union powers
• Reducing red-tape to cut small business costs
• Measures to improve the flexibility of the labour market/reforming employment laws
• Policies to boost competition such as deregulation and tough anti-monopoly and anti-cartel laws
• Privatisation of state assets (selling off public sector businesses into the private sector) e.g. Royal Mail (2013)
• Opening up an economy to overseas trade and investment
• Opening up an economy to inward labour migration
What are examples of supply-side policies?
- Lower taxes, encourage investment
- Increase funding for education
- Reduce union power
- Training schemes, increase mobility of labour
What are the effects of government spending on healthcare?
- More fit and healthy workforce will improve productivity shifting LRAS to the right
BUT - Spending needs to be done efficiently or it may all be spent on bureaucracy like administrative paperwork
What is the average annual loss of productivity in the UK?
£77 billion
What are the results of government spending on education?
Advantage - In the long run workers will become more productive, this is vital for the UK as its output per worker is 26.5% less than America’s (gov spending through subsidy may also increase AD)
Disadvantage - In the short run, more students means less people in the workforce. As shown below, this will decrease labour supply and push wages up. An increase in wages will increase production costs for firms which in turn will reduce SRAS.
What does SRAS assume?
Prices and productivity of factor inputs are held constant
What are the results of government spending on infrastructure?
Investing in infrastructure such as ‘roads, bridges, highways’ will decrease the geographical immobility of labour (or increase the mobility!). This will increase the productivity of labour as more labour becomes readily available to firms, leading to an increase in LRAS.
What are 5 examples of market-based policies?
- Deregulating
- No or reducing minimum wage
- Privatisation
- Free trade
- Decreased tax rates
What is deregulation to boost LRAS?
Postal services and the UK energy industry promote competition, promotes investment, increases efficiency
What is privatisation to boost LRAS?
- More efficient
- More productive
- Raises funds for government to spend elsewhere
- Dynamic efficiency
What is the advantage and disadvantage of removing minimum wage?
Advantage - Lower costs of production increased AD and AS
Disadvantage - 1.9 million workers get minimum wage so they will consume less. Workers may emigrate elsewhere causing a decrease in the labour supply which will shift long-run aggregate supply to the left
What is the result from decreased income tax?
Advantage - A decrease in income tax will increase the incentive to work and therefore increase the labour supply. An increase in labour supply will cause the wage to decrease. This is then a decrease in the cost of production for firms which will cause the SRAS to shift to the right. More consumption, AD shift out
Disadvantage - If workers increase their leisure time and decrease their work hours, there will be a decrease in labour supply. This will increase wages, which will increase the cost of production and cause a shift to the left of the short run aggregate supply curve.
What is the result from decreased corporation tax?
Advantage - Reduces costs of production, more profit outward shift in LRAS, also increases availability of money so increased investment
Disadvantage - Reduced government spending due to less tax revenue. This money could have been spent on education / multiplier effect. £5 billion cut in the last 13 years
Why may decreasing tax lead to an increase in tax revenue?
- Increase in firms choosing to base themselves in the UK
- Increased investment by UK firms leading to increased profits
- Reduced tax evasion/avoidance
What is the US central bank called?
Federal Reserve
How often do the MPC meet?
Monthly
What is one difficulty the MPC has in determining monthly rate of interest?
Wage rates - can be a cause of demand pull and cost push inflation, rate of economic growth compared to long-run trend rate, fluctuations in the price of commodities, consumer spending levels, investment levels, consumer confidence, difficulties in predicting future trends
How might economic growth cause lower living standards?
Economic growth might be achieved at the expense of longer working hours and shorter holidays. Also, there might be an increase in external costs, e.g. pollution, which results in a lower quality of life.
What are the limitations of supply-side policies?
• Tax cuts favour those with high incomes
• Cutting benefits = poverty
• Reduced worker rights = may be unpopular
• Timelags in showing effects (2 years)
- Opportunity costs
Explain how the use of interventionist supply-side policies may constrain aggregate supply.
If the government spends billions of pounds intervening in the economy, it makes it harder for private firms to invest in capital
Impact of increasing interest rates on house prices
Decreases (less demand for houses)
Impact of increasing interest rates on inflation
Decreases (people save more and wealth effect discourages consuming)
Impact of increasing interest rates on mortgage payments
Increase (decreased disposable income, inflation goes down)
Impact of increasing interest rates on exchange rates
Increase (people want to save in the UK economy so they switch to the currency)
Policies to reduce inactivity of the workforce
Investment into healthcare and allow greater migration of skilled workers
Supply side policies cause
An increase in LRAS
Three examples of current supply side policies
1) Heathrow new runway 2) HS2 3) Elizabeth Line
What are bank reserves?
Assets held by a bank to fulfill its deposit obligations
What is a wage-price spiral?
Rising wages cause higher prices and higher prices cause higher wages
What is the Environmental Kuznets Curve?
As per capita increases, environmental degradation first increases and then decreases due to tech advancements
What is the Kuznets hypothesis?
As a country moves away from primary industry, inequality rises as wages in manufacturing rise faster, but then inequality reduces as government redistributes income
What does the Phillips Curve indicate?
A short-run inverse relationship between inflation and unemployment rates
Explanation of the Phillips Curve
Government policy to reduce unemployment can cause demand pull inflation, e.g. expansionary fiscal policy
Conflict between inflation and unemployment
If the government tries to reduce unemployment, it will subsidise firms, resulting in increased inflation
Are low unemployment and economic growth conflicting or complimentary?
Complimentary, as growth creates more work opportunities, reducing unemployment
Are economic growth and balance of trade conflicting or complimentary?
Conflicting, as growth increases consumption, leading to more imports
Are economic growth and low environmental degradation conflicting or complimentary?
Conflicting, as growth depletes resources, but Kuznets curve suggests long-term improvements
Are low unemployment and 2% inflation conflicting or complimentary?
Depends on the Phillips curve
Are economic growth and 2% inflation conflicting or complimentary?
Conflicting due to growth leading to high inflation, but may not if supply-side policies are used
Fiscal and monetary policy conflict
Loose fiscal policy may lead to inflation, countered by raising interest rates
Monetary policy and supply-side policy conflict
Increasing interest rates decreases production, leading to cost-push inflation
Supply-side policy and fiscal policy conflict
Contractionary fiscal policy may hinder supply-side effectiveness in the short term
Supply-side policy and fiscal policy positive overlap
Increased government spending on healthcare or education can enhance supply-side policy effectiveness
Effect of supply side policies in the short run vs long run
Short run increases budget deficit; long run decreases budget deficit
Why do wages increase when unemployment is low?
Workers have more bargaining power and demand higher wages
Why does inflation result from lower unemployment?
Higher wages increase cost of production, leading to higher price levels
Against point - inflation may not result from unemployment
Adaptive expectations may lead to only slight price increases despite higher wages
Inflation rate in 1975
24.24%
Evidence from December 2019 that the Phillips Curve has flattened
Inflation rate was 1.8% but unemployment rate was 3.9%
How has the 2008 financial crisis left Britain in policy paralysis?
High debt, low interest rates, credit crunch
What is a credit crunch?
A lack of funds in the credit market, making financing difficult
Advantage of increased government spending on infrastructure as a supply side policy
Improves geographical mobility of labour
Disadvantage of increased government spending on infrastructure as a supply side policy
Might crowd out private firms
Evaluation of supply side policies
Opportunity cost, time lag, budget deficit
Argument that a lower base interest rate won’t lead to increased investment
Depends on firms’ expectations about consumption
What are automatic stabilizers?
Changes in fiscal policy that adjust aggregate demand without deliberate action
Example of an automatic stabilizer
Unemployment compensation, food stamps, progressive income tax system
Difference between automatic stabilizers and fiscal policy
Automatic stabilizers vary without direct government action; fiscal policy requires government enactment
What is current expenditure?
Government spending on day-to-day public sector operations
What is capital expenditure?
Spending on business resources used repeatedly over time
Difference between ‘workforce’ and ‘labour force’
Workforce includes all willing and able to work, including inactive population
Why may an increase in unemployment not cause an inward shift in PPF?
Could be firing inefficient workers or due to technological advancements
How does the multiplier process lead to an increase in AD?
Initial change in AD has greater final impact through circular flow of money
Role of the World Bank
Provides aid and advice to developing countries, reducing poverty and encouraging investment
Role of the IMF in providing financial assistance
Enables growth, provides loans, promotes stability and cooperation
World Bank aid in 2016
$61 billion
Role of NGOs
Represent society, advocate policy change, but may be ineffective due to low budgets
What is capital flight?
A large and sudden reduction in demand for assets in a country
What causes capital flight?
Inappropriate policies, expected currency devaluation, high political risk
What happens to a country’s currency value as a result of capital flight?
Depreciation
Reasons for increased unemployment post 2016
Brexit uncertainty, increased automation, slower economic growth
What is the domestic economy?
Work associated with obtaining food for a family or household
Increased credit card lending effect on inflation
AD shifts outwards, price level increases
Why may Country A’s unit labour costs rise faster than other countries?
Faster economic growth, lower unemployment, lower productivity, etc.
Why may revenue from corporation tax increase despite cuts in the tax rate?
More firms in the UK, increased profits, reduced tax evasion
Why may global wealth inequality have increased?
Rise in asset prices, lack of education, inheritance, MNCs, etc.
Why is CPI a bad measure of inflation?
Excludes certain income brackets, does not reflect changing preferences
What is a regional trade agreement?
A trade agreement between countries in a geographical region, e.g. NAFTA
