Theme 2 - The UK Economy - Performance And Policies Flashcards
What is the breakdown of spending in the UK economy?
65% - consumer spending (C)
25% - government spending (G)
15% - investments (I)
What percentage is spending in the UK economy?
105%
What does X - M mean?
Exports - Imports
What value is X - M equal to?
-5%
What are the 2 names in ‘The Circular Flow of Income’ diagram?
Households
Firms
What are the 3 injections into the UK economy?
- government spending (G)
- investments (I)
- exports (X)
What are the 3 withdrawals out of the UK economy?
- savings
- taxes
- imports (M)
When injections > withdrawals… (2)
There is greater GDP and the economy grows
What are the 3 methods to calculate economic activity?
- expenditure method (sum of all spending)
- output method (sum of total output by firms)
- income method (sum of total value of income of firms)
The 3 methods to calculate economic activity should be…
… the same but might not be due to correction values
In terms of ‘The Circular Flow of Income’, what is transferred from Households to Firms?
Capital, land, labour, enterprise (CELL)
Expenditure on goods and services (GDP)
In terms of ‘The Circular Flow of Income’, what is transferred from Firms to Households?
Goods + services
Interest, profit, rent, wages (in order of CELL)
What is GDP?
The total amount of all spending within an economy
What are the 4 ways of measuring Economic Output?
- GDP (output of goods and services)
- nominal GDP (doesn’t include inflation)
- GDP per capita
- GNP (Gross National Product) (also includes earnings from overseas)
What are the government’s 7 economic objectives? (I busied)
- inflation (2%)
- balance of payments (exports/imports)
- unemployment rate
- sustainability
- inequality
- economic growth
- debts
What is Aggregate Demand?
The total amount of demand in the economy
What makes up Aggregate Demand?
C - consumption - 65%
I - investments - 15%
G - government spending - 25%
X - exports
M - imports
Equation for Aggregate Demand
C + I + G + (X - M) = -5%
What is consumption?
The expenditure on goods and services by consumers
What are the main factors that influence the levels of consumer spending? (6)
- income (disposable)
- inflation rate
- taxation
- confidence
- interest rate
- trends/fashion
What is trend growth?
The estimated rate of growth of a nation’s productive potential
Name all the parts of a trend growth graph (7)
- trend growth line (straight, tilted gradient)
- boom
- peak
- recession
- depression
- trough
- recovery
What are the x and y axis labelled in an economic growth graph?
X-axis - time
Y-axis - GDP
Describe where each term is located on a trend growth diagram (6)
- boom - increase above trend growth line
- peak - high point after boom but before recession
- recession - decrease above trend growth line
- depression - decrease below trend growth line
- trough - low point after depression but before recovery
- recovery - increase below trend growth line
What are the 3 main types of government spending?
- current expenditure
- capital expenditure
- transfer payments (benefits)
Key factors influencing consumer spending (11)
- amount and changes to real disposable income (Yd)
- employment and job security
- availability and cost of consumer credit
- rate of interest
- cost of servicing a mortgage
- the wealth effect (changes in asset price) (physical or monetary)
- future price changes (inflation, disinflation, deinflation)
- consumer confidence/pessimism
- expectations
- composition of households (% of total disposable income)
- level of savings
What is marginal propensity to consume? (Include equation)
The proportion of a raise in income that is spent on the consumption of goods and services
MPC = change in consumption / change in income
What is marginal propensity to save? (Include equation)
Proportion of an increase in income that’s saved
MPS = change in saving / change in income
Equation including MPC and MPS
MPC + MPS = 1 = increase in income
0.6 + 0.4 = 1
Types of investment (3)
- capital
- gross
- net
What is capital investment?
Spending on machinery, equipment, factories, technology and infrastructure to create new capital goods
What is gross investment?
The total amount that the economy spends on new capital (includes capital depreciation)
What is net investment?
Gross investment - cost of depreciation of those assets
Factors influencing investment (7)
- interest rates + availability of business finance/credit
- expected profits + retained profits + business taxes
- actual + expected demand for goods + services (accelerator effect)
- business confidence (ie animal spirits)
- rate of technological change
- price of product + risk related to it
- government policy
What are the main areas of government spending? (7)
- health and social care
- education
- debt interest
- defence
- transport
- home office
- justice
What 2 things should be balanced to meet the government’s budget?
Expenditure and Income
How long is a deficit for?
1 year
How long is a debt for?
The accumulative deficits
A budget (fiscal) deficit is when… is greater than…
Spending > Income
Debt is…
The % of GDP
What is a bond?
When the government borrows money and then pays it back with interest
The interest on bonds is called…
Yield
What are the 5 types of unemployment?
- frictional
- structural
- cyclical
- seasonal
- real wage
What is frictional unemployment?
When someone is out of work due to personal short term unemployment
What is structural unemployment?
When someone’s skills are no longer relevant
What is cyclical unemployment?
When someone’s unemployed due to economic reasons
What is seasonal unemployment?
When someone has no work during parts of the year
Consequences of unemployment (6)
- reduced consumption
- cost to the government (opportunity cost and reduced tax)
- cost to taxpayers (increased tax)
- businesses may have to close
- the unemployed person’s skills become more irrelevant as time passes
- lower GDP
Causes of unemployment (9)
- high interest rates
- global recession
- negative multiplier effect
- financial crisis
- technological change
- real wage unemployment
- geographical immobility
- structural-mismatch of skills
- frictional
Someone is classed as unemployed if they are (4):
- out of work
- available for work
- actively seeking employment
- aged 18-66
Measures the government are taking to get more economically inactive people to work (4)
- back to work schemes
- work experience
- cutting their benefits
- training programmes
What does economically inactive mean?
Someone of working age (18-66) who isn’t employed or been looking for work in the past 4 weeks
What does LFS stand for?
Labour force survey
What is another name for the LFS?
The ILO
What is the LFS?
A survey of 80,000 people across society that counts those without a job in the last 4 weeks and who can start a job within the next 2 weeks
What are the criteria for the LFS? (3)
- those without a job in the past 4 weeks and who can start a job in the next 2 weeks
- aged 16-70
What are some of the advantages to using the LFS (compared with the C.C)? (4)
- used in Europe (comparable)
- wider criteria
- measures ‘students’ and ‘retirees’
- measures underemployment
What are the problems with LFS (compared to C.C)? (3)
- can be out of date
- people may lie
- more expensive to create
Fisical policy effects…
Demand
What is the fisical policy/how does it work?
It uses taxation and government spending to impact demand
- increase tax to reduce demand
- reduce tax to increase demand
What is fisical drag/how does it work?
The government keeps income brackets the same but increases wages which means they collect more taxes but people are happy to recieve increased wages
Increasing government spending… aggregate demand
Increases
Government spending is around …% of GDP
45%
What are the impacts of government spending? (4)
- increase in AD
- multiplier effect
- offsetting economic declines
- infrastructure (increases business investment, productivity + demand)
Inflation is…
The general increase of prices
Deflation is…
The general decrease of prices
Consumer price index … mortgage interest payments
…excludes…
Retail price index … mortgage interest payments
…includes…
Inflation leads to…
A fall in the real value of money
What is demand pull?
When consumers have too much money they spend too much then prices start to rise as they outbid each other
What is cost push?
When suppliers see an increase in their own costs so they push them onto the consumer
What is the equation for working out the multipler for the multiplier effect? (3)
1 / (1-MPC)
or
1 / (MPS + MPT + MPM)
or
1 / (MPW)
What is the wealth effect?
When someone’s income increases, their consumption is expected to increase too
What are the factors that affect the multiplier value and how? (4)
- MPC - higher leads to a larger multiplier value
- Leakages - higher leads to a lower multiplier value
- Degree of spare capacity - little spare capacity limits the multiplier value
- Time frame - in the ST factors such as capacity constraints and rigidities in adjusting production limits the multiplier value
How do we measure inflation?
Base year index + price change (%) = price index
Price index x weighting = price-weighted index
Total price-weighted index / 100 = new index number
New index number - base year index = inflation (%)
What is the target for inflation?
1% either side of 2% (1%-3% range)
Net trade = … + …
Imports + exports
The balance of payments measures…
All international economic transactions between the UK and it’s trading partners
The 3 accounts in the balance of payments are…
- current account (-)
- capital account
- financial account (+)
The visible balance is… and the invisible balance is…
Negative / positive
The trade deficit is… so the financial account must be…
Negative / positive
A trade surplus is… so increases AD
A positive net trade balance
A trade deficit is… so reduces AD
A negative net trade balance
Factors influencing exports of goods + services (4)
- relative prices of exports in world markets
- the exchange rate (stronger currency makes exports more expensive)
- non-pride demand factors (eg design + branding)
- strength of AD in key export markets
When interest rates increase demand for the £…
Increases
Oil prices are…
Volatile
What are some solutions for bringing down high interest rates (9)
- increase NI
- increase income tax
- increase interest rates
- increase fuel duties
- increase VAT
- increase property tax (stamp duty)
- freeze pay rises
- freeze minimum wage
- freeze energy bills
What does the current account measure?
Imports vs exports
What does the capital account measure?
Sale of assets (capital)
What does the financial account measure?
Investments (inc foreign) + foreign businesses in UK
What are remittances?
Sums of money sent voluntarily home by migrants abroad
What’s the difference between imports/exports?
Imports - goods/services coming into the country
Exports - goods/services exiting the country
What’s the difference between visible/invisible trade?
Visible - goods
Invisible - services
Supply-side policies stimulate production among the nation’s firms by either:
- reducing the costs faced by firms (labour policies)
- improving the productivity of human and physical capital (capital policies)
Examples of Interventionist Policies:
- spending on healthcare
- building business parks
- increased education and training
- improving transport and infrastructure
- invest in social (council) housing
Examples of Market Policies:
- reducing the power of Trade Unions
- privatisation of State Industry
- lower tariff barriers
- removing unnecessary red tape
- reduce corporation tax
- reducing state welfare benefits
- providing better information about jobs
- deregulation
What is the output gap?
The difference between the actual level of GDP and its estimated potential level
What’s a negative output gap?
- when the economy’s output or GDP is below its potential output
- when actual output falls below this potential level
- corresponds to higher unemployment and under utilised resources
What’s a positive output gap?
- when output or GDP exceeds potential output
Reasons for a fall in AD (5)
- fall in net exports
- lower government spending
- decline in household wealth and confidence
- higher interest rates
- higher tax rates
Reasons for an increase in AD (4)
- depreciation of the exchange rate
- cuts in direct and indirect taxes
- increase in house prices
- expansion of supply of credit + lower interest rate
What is an economic shock?
When an unexpected event causes changes in the level of demand, output and supply
Aggregate supply is the total… that firms in an economy are willing and able to supply at a given…
Output of goods and services / price level
Long run Aggregate Supply represents a maximum output when…
All factors of production are fully and efficiently employed
Short Run Aggregate Supply assumes… in the short run when drawing the SRAS
productivity and costs of production and the state of technology is constant
A decrease in costs for firms throughout the economy will cause… shift in SRAS
an outward
Factors that cause shifts in Short run Aggregate Supply: (7)
- unit wage costs (higher minimum wage)
- labour productivity
- key raw material prices
- energy costs
- business indirect taxes
- supply shocks
- cost of imported materials
Factors that cause shifts in Long run Aggregate Supply: (8)
- improvements of technology
- increased workforce
- increased productivity/efficiency of allocation
- labour supply
- natural resources
- quality of inputs
- improvements in institutions
- stock of capital inputs including infrastructure
Examples of supply shocks (4)
Brexit, Covid, Ukraine/Russian war, Holy land war
Long Run Aggregate Supply is…
The maximum possible output, like a country’s PPF
Describe the Keynesian Non-Linear Aggregate Supply Curve
Price on y-axis
Real GDP on x-axis
Straight horizontal line then sharp increase in Aggregate Supply
Why are business parks a good idea? (5)
- modern amenities
- professional working environment
- enhanced productivity
- employee satisfaction
- shared resources and collaboration
Examples of infrastructure (5)
- motorways
- airports
- universities
- sea ports
- train stations
Benefits of investing into infrastructure (4)
- economic growth
- encourages trade
- increases educated and skilled workers
- increased supply of raw materials
What is a trade union and what does it aim to do?
It’s an organised association of workers in a profession.
It seeks to protect workers’ pay and workers’ rights.
Examples of industrial intervention (5)
- strikes
- overtime ban
- organised calling in sick
- go-slow
- work-to-rule
How long must unions employers give notice before a strike?
14 days
Definition of collective bargaining
A voluntary process used to determine terms and conditions of work and regulate relations between employers, workers and their organisations, leading to the conclusion of a collective agreement
Definition of industrial action
Usually happens when a dispute in the workplace can’t be resolved through negotiation
Definition of holding a ballot
When a union has a vote that’s properly organised according to legal rules
Definition of minimum service levels
The minimum number of workers required to provide the particular service during a strike
What is privatisation?
Selling a state industry to the private sector.
It is then owned and run by shareholders and is run as a company and seeks to deliver a profit.
Examples of privatisation (5)
- British Airways
- British Gas
- BT
- British Airport Authority
- British Rails
Types of privatisation (4)
- selling shares (PLC)
- contracting out (private contracts)
- competitive tendering (construction of projects)
- public private partnership (work in partnership)
Benefits of privatisation (3)
- the government receives a large lump sum
- no longer has to pay for its running costs
- customer gets better service and more innovation
Problems of privatisation (4)
- prices may go up because the aim is profit making
- may be worse quality
- they are no longer answerable to taxpayers
- the company may cancel services to certain areas because they’re not making enough money there
Describe the Keynesian LRAS curve
- starts off horizontal
- curves suddenly upwards
- vertical line
Difference between keynesian economists and classical economists
Keynesian - G is the most important economic activity
Classical - a self-regulating economy is efficient + no need for government intervention
What are the 2 main parts of Fiscal Policy?
Taxation + Public spending
What are the 3 types of taxation?
- progressive - rate of tax increases as income increases
- proportional - rate of tax is constant
- regressive - rate of tax decreases as income increases
What are the 3 main areas of government spending?
- capital
- transfer payments
- infrastructure
What is loose/expansionary fiscal policy?
Increases AD by increasing government spending
What is tight/contractionary fiscal policy?
Reduces demand by lower government spending
For loose fiscal policy, taxation is … and government spending is …
Decreased / increased
For tight fiscal policy, taxation is … and government spending is …
Increased / decreased
Evaluation points for expansionary policy (7)
- magnitude
- ST / LT (time-lag)
- MPS and MPC
- higher market interest rates
- an acceleration in the rate of price inflation
- MPM
- rise in business confidence
What are the main tools used in fiscal policy?
- government spending
- taxation
What is crowding-out?
Private investors are put off spending/investing due to:
- bonds are issued, which takes their money (disposable)
- interest rates are pushed up
- taxes are increased in the future
Ways the government uses fiscal policy to have an effect on families’ disposable income (13)
- welfare state transfers
- universal child benefits
- public (state) pensions
- conditional welfare transfers
- targeted welfare payments rather than universal subsidies
- state-provided services
- education
- healthcare
- social housing
- wage subsidies
- employment training
- progressive income taxes
- tax-free allowances for lowest income households
What are automatic stabilisers (automatic fiscal changes)?
Changes in tax revenues and state spending arising automatically as the economy moves through the trade cycle
In a boom period, government spending… and taxes are…
Decreases / increased
In a recession period, government spending… and taxes are…
Increases / decreased
What are discretionary fiscal changes?
Deliberate changes to government spending and taxation
Monetary policy deals with the … side
Demand
What are the 4 functions of money?
- medium of exchange
- store of value
- unit of account
- standard of deferred payments
What are interest rates?
The reward of saving and the cost of borrowing
What are the 4 parts of monetary policy?
- interest rates
- credit availability
- quantitative easing
- quantitative tightening
What is the MPC?
The Monetary Policy Comittee
What value does the MPC want consumer price inflation at?
2%
Definition of deregulation
The opening up of a state monopoly. The market is then open to competition.
Examples of deregulated services (4)
- telecoms
- airline industry
- banking
- gas/electricity
Advantages to deregulation (4)
- increased competition
- more efficient
- more price competition
- greater consumer choices
Disadvantages to deregulation (4)
- creates a private monopoly
- duplication of services (buses)
- private firms cut costs
- better the devil you know (better to stick to the firms you know, trust and can hold to account)
What are the factors that the MPC consider when changing the interest rates? (9)
- unemployment figures
- consumer/business confidence
- economic growth (GDP)
- bank lending
- equity markets (share price) + house prices
- growth of wages, average earnings + unit labour costs
- international data
- trends in global foreign exchange rates
- inflation expectations
What is the Transmission Mechanism of monetary policy?
The several ways in which changes in interest rates influence aggregate demand, output + prices
Tight … policy + loose … policy –> reduce the deficit
fiscal / monetary
It can take between …-… months for the full effects on real GDP and the inflation rate after a change in policy interest rates
12-24 months
What is deregulation of labour markets?
Where the government reduce the amount of employee rights to make it easier for firms to hire and fire workers
What is a zero-hour contract?
Employees are on call to work when they are needed but they don’t have to be given work
Benefits to zero-hour contracts (8)
- flexibility
- profits increase
- costs decrease
- staff can work more hours
- output increases
- consumption increases
- profits can be reinvested into the business
- easily hired
Problems with zero-hour contracts (10)
- high pressure/stress (lots of work)
- may not be offered any hours
- job security
- employees could be paid less
- lack of predictability (other commitments)
- low skilled jobs
- no set income or hours
- possibly poor mental health
- staff might decline the hours
- easily fired
Definition of redundancy
A form of dismissal from one’s job - employers need to reduce their workforce
What is “red tape”?
Too many regulations, form filling and quality checks
What are the 2 factors of monetary policy?
- interest rates
- credit availability
Is tight or loose monetary policy used for economic growth?
Loose
How does loose monetary policy lead to the £ appreciating?
Loose policy – interest rates decrease – increase of investments (hot money) – increase demand of the £ – the £ appreciates
How do exchange rates affect the rate of inflation? (3)
- change in the prices of imports
- commodity prices and the CAP
- changes in the growth of UK exports
Evaluation points for the effects of exchange rates (4)
- uncertain time-lags
- low price elasticity of demand
- counter-balancing use of fiscal + monetary policy
- keep interest rates low
What is quantitative easing?
Monetary policy tool used by central banks to stimulate the economy
What are the steps of QE? (5)
- central bank creates new money electronically by adding money to their balance sheet. This money is then used to buy financial assets.
- more demand leads to higher prices for assets. Rise in price of bonds leads to lower yield (%) on bonds.
- the effect of QE can then cause a fall in long term interest rates e.g. mortgages and corporate bonds
- lower interest rates and increased cash in the banking system should stimulate AD through a rise in consumption and investment.
- extensive QE also works through the exchange rate - lower yields on assets usually cause a currency depreciation.
Economic effects of higher interest rates in the UK (5)
- consumer spending decreases
- household savings increases
- investment decreases
- asset prices decreases
- exchange rates (imports become cheaper + appreciation of domestic currency)
Evaluation points for QE (3)
- want LI groups to buy bonds to increase consumption (but don’t due to confidence + risk of getting more debt) but HI groups may buy bonds instead and then invest in assets which takes the money straight out of the circular flow
- the BOE (central bank) holds most of the UK government debt
- after the financial crisis, banks were less willing to loan money
What is the liquidity trap?
There is a level below which interest rates cannot go and at that point monetary policy may become powerless.
Moreover, even if interest rates can be lowered, it may have no effect on peoples’ willingness to borrow.
What does the Philips Curve look like (including what the axis are labelled as)?
x-axis - unemployment rate (%)
y-axis - inflation rate (%)
Curve is labelled as SRPC and is in the bottom left corner
The SRPC goes below the x-axis
What does the SRPC going below the x-axis tell us?
The rate has become so low it is now ‘deflation’
What does the Philips Curve tell us?
Inflation and unemployment have an inverse relationship (it’s a trade-off e.g. if the government decreases unemployment, inflation increases)
What’s a classical argument against the Philips Curve?
In the 1970-80s it became less effective with the use of monetary policy because we achieved both low unemployment and low inflation
What is deflation?
The general decrease in prices (negative inflation)
What is disinflation?
Inflation (increase in prices) but at a lower rate than before
Demand-side causes of deflation:
- a deep fall in AD causes a persistent recession/depression
- a large negative output gap (i.e. high levels of spare capacity)
Supply-side causes of deflation:
- improved productivity
- technological advances
- a significant fall in wage rates
Reasons why deflation may damage an economy (7)
- holding back on spending
- debts increase
- the real cost of borrowing increases
- lower profit margins
- confidence and saving
- income distribution
- can make exporters more competitive eventually
What is quantitative tightening?
A deflationary monetary policy to reduce inflation
What were the main 2 causes of the 2008 financial crisis?
- US housing and mortgage bust - over lending and introductory deals that attracted low income earners
- selling of mortgages between banks - prime (could repay) and surprise (struggled to pay) mortgages together to spread risk but then all banks were impacted
What is crowding-out?
- expansionary fiscal policy (increase G and decrease taxes)
- government issue bonds
- people giving the government money then don’t have that money to spend
- increase value of bond to attract people to buy bond
- interest rates increase to attract borrowing which means more people buy bonds
What is the liquidity trap?
- when interest rates get to a certain low value, any lower points aren’t going to have a significant impact on borrowing
- money is trapped
- might be in debt
What is the accelerator theory?
When there is an increase in output (GDP), there is an increase in investments
Definitions of income and wealth
Income - the flow of money into a household at a given point in time.
Wealth - the value of assets within a household at a given point in time.
Causes of poverty (19)
- illness
- education
- lack of job opportunities
- carer for someone
- lack of ambition
- addiction (demerit goods)
- conflict
- social injustice
- lack of infrastructure
- lack of government support
- rising living costs
- crime
- poor healthcare
- redundancy
- (credit) debt
- lack of nutrients or food/water resources
- weather/climate
- low paid jobs
- old age
Ways of reducing inequality (3)
- paying benefits
- a progressive tax system
- greater investment in education, healthcare and infrastructure
What is a progressive tax system?
Is a tax in which the tax rate increases as the taxable income increases. It is a way of redistributing money.
What is the trickle-down effect?
Policies that disproportionately favour the upper tier of the economic spectrum, comprising wealthy individuals and large corporations.
The policies are based on the idea that spending by this group will “trickle down” to those less fortunate in the form of stronger economic growth.
Problems with the trickle-down effect (3)
- money may not actually be spent (money may be saved instead)
- money may be spent in richer businesses/firms
- less tax-revenue for the government
The happiness indicator is…
A way to measure welfare (looking beyond income/wealth)
Factors that influence happiness (10)
- mental/physical health
- income
- friends/family/relationships
- location
- crime levels
- job
- access to healthcare/education
- leisure
- hobbies/interests
- work/life balance
What is HDI (Human Development Index)?
A broader measure of society that looks at income, health and education.
Reasons for a high HDI (6)
- education
- high income (GDP/capita)
- good healthcare
- high average life expectancy
- low crime rates
- stable governments
What is sustainability?
Meeting the needs of today without taking away resources from the future.
