Theory Flashcards
relationship between real income and subjective happiness
- happiness + income positively rated at low incomes: if poor and income ↑, happier
- happiness + income not associated at high incomes: if rich and income ↑, not necessarily happier
limitations of CPI
- impossible to account every single good sold, so not representative
- doesn’t include housing price which rises more than other goods, so CPI ↓ than shld be?
RPI vs CPI
- RPI has housing costs
- CPI takes into acct when prices up, consumers switch to good that has gone up least (= CPI usually lower than RPI)
- CPI covers all households, RPI excludes top 4% income earners and low income pensioners as not ‘average’ households
fisher equation
MV = PT
- M is money supply
- V is speed of money circulating in economy
- P is price level
- T is number of transactions
growth of money supply
- cause of inflation
- if ppl have access to money, will want to spend, but if no ↑ in amount of goods/services supplied, prices will have to ↑
inflation effects (cons, firms, workers)
C:
- if income doesnt ↑ with inflation, less to spend
- if in debt, can pay off at ‘cheaper’ value
- if owed, lose money as money received is ‘cheaper’ value
- psychological effects, prices rising so feel less well off, ↓ spending
F:
- if inflation in UK higher than other countries, less competitive
- inflation/deflation/disinflation is hard to predict so cant plan for future
W:
- if pay rise doesn’t match inflation, earning less so SoL ↓.
- deflation = loss of jobs as low demand = low profits so firms have to cut costs
unemployment impacts (workers, firms, cons, govt, society)
W:
- loss of income, ↓ SoL
- long-term loss skills, less employable in future
- lower job security
F:
- ↓ of demand for goods, so profit ↓
- loss of worker’s skills, so fewer options for skilled labour
- can offer low wages as ppl will still take job
C:
- less choice of goods, maybe quality ↓
- unemployed consumers have less to spend
- firms may lower prices/ do sales to ↑ demand
G:
- ↓ tax rev as less income, ↑ spending on welfare payments, opportunity cost as money cld be better used elsewhere
- increase in budget deficit
S:
- social deprivation (crime ↑ etc)
- loss of potential national output
parts of the current account
trade in goods:
- known as visibles as can see them
- goods that are traded (raw materials or finished goods).
- balance of trade is diff between visible X and visible M
**trade in services: **
- services traded in/out of country
- holiday to Spain by british fam is invis imp as money leaves UK and goes to spain
- Japanese buying insurance from city of London firm is invis export as money into UK
income and current transfers
- Wages, interest, profit or dividends can be
repatriated into the country.
- e.g. Polish person could send money earned in the UK back to Poland or British person could take the profits from
overseas country back to the UK.
- Current transfers usually done by
govts, when they transfer money into/out of overseas organisations like EU.
current acc imbalances w/ other macro objectives
- high econ growth often means current ACC = deficit, as ↑ imp due to ↑↓ demand
- govt wants export-led growth, which wld lead to econ growth, high emp, and improve current acc balance, BUT inflation
interconnectedness of economies
- proprtion of output of an individual economy which is traded internationally is growing
- more people / companies own assets in other countries e.g. shares/loans/businesses
- increasing migration
- more tech being shared
influences of net trade balance
real income:
- high real income, high demand so UK unable to meet demands, so imports increase so net trade worsens
- if real income up cos export-led, net trade up
exchange rates:
- strong pound vs weak pound WIDEC SPICED
- elasticity
state of world economy:
- if world doing good, and UK export countries doing good, exports up
degree of protectionism:
- if high protectionism for UK firms in other countries, exports down
- free trade (no protectionism) means trade more significant part of AD
non price factors:
- quality/design of goods (higher quality Uk goods means higher exports)
factors influencing short-run AS
changes in costs of raw materials and energy:
- increase in cost means increased cost of prod
- SRAS left as higher cost to make same goods
changes in exchange rates:
- WIDEC SPICED
- strong pound means imports cheaper, production cheaper
changes in tax rates:
- taxes = increased CoP, so fall in SRAS. subsidies shift right
supply side shocks when any of these change significantly
classical
- in SR, can exceed max potential as can work overtime, but in LR, workers will want a break etc.
Keynesian
- upward sloping to show that after a certain point, increasing ad only leads to inflation and not growth
- Arguing that gov should focus on lras during a boom
- And ad during a bust
- sticky wages: workers not willing to take lower wages cos of recession
factors affecting LRAS
tech improvements:
- speeds up production, so more goods produced w/ same resources
relative productivity changes:
- increased productivity means more produced w same resources
- if UK more productive than other country, int comp better, encouraged production
education and skill changes:
- more skilled workforce is more employable
govt regulations changes
- can implement policies to increase size of workforce, or increase R+D, make barriers to entry for new firms easier (more jobs, more output)
demographic changes and migration
- if immigration > immigration, population rise so more workers, increase lRAS
- immigrants age important, working vs ageing/youth
effects of multiplier on economy
- growth can occur quicker as any injections lead to a BIGGER increase in national income
- HOWEVER, impossible for govt to know exact effect of spending, cld be unintended outcome
- time lag between spending and outcome
export led growth
- increased exports initially increases AD rather than LRAS
- sustained high export levels will encourage / force firms to invest and increase demand for labour to produce goods
- will lead to economic growth.
- will have to be more efficient to stay competitive as competing w/ more firms than in just UK market
boom characteristics
- national income high
- likely working above PPF, positive output gap
- consumption and investment ↑, tax rev ↑
- increased imports to meet demand of high-income consumers
- inflationary pressure
characteristics of a recession
- high unemployment
- ↓ consumption, investment and imports
- low inflationary pressure (maybe deflation)
- where real GDP falls in 2 successive quarters
econ growth consumer impact
- ↑ demand for housing, as more money so can buy properties
- positive wealth effect (ppl spend more as the value of their assets rise)
- ↑ productive efficiency as better tech, ↓ prices/↑ quality goods
- increased happiness
- BUT increased inequalities? inflation?
econ growth firm impact
- confidence ↑
- ↑ investment as businesses more successful
- more money + incentive to invest as know can make profit
- from investment, ↑ tech and R+D, so ↓ costs
- ↑ demand and ↓ costs = ↑↑↑ profit
- opportunity for new firms
BUT firms selling inferior goods may lose out
econ growth govt impact
- tax rev ↑ (↑ goods + services, ↑ jobs so ↑ income)
- can re-invest, help living standards (e.g NHS)
- reduced budget deficit
BUT, econ growth = ppl expect more from govt (better education, better roads)
econ growth current + future living standards impact
- ↓ poverty levels as ↑ jobs
- more goods and services available, so less wealthy can afford
- ↑ housing standards, and quality of food
- ↑ govt spending
BUT living standards ↓ if exploitation of env - HOWEVER ↑ income so can buy cleaner fuels, use more ‘green’ and efficient tech
- increased ineq?
primary macro objectives
- low unemployment (less than 5%)
- low and stable inflation (2%, +/- 1%)
- economic growth @ similar to other econs,
(strong, sustained, sustainable - 2.5%) - balanced
(BoP equilibrium, including current acc. bal)
secondary macro objectives
- balanced govt budget (debt to GDP lower than 60%)
- protection of env (less carbon emissions, more renewable energy)
- greater income ineq (gini coefficient)
increase in interest rates:
- increased cost of borrowing, so saving more attractive (Cons. down, invest down)
- due to less borrowing, less demand for stocks, shares and govt bonds. so fall in prices of assets (-ve wealth effect)
- consumers less confident, so decreased C and I, so AD down. mortgages more expensive, so less disposable income.
- higher interest = incentive for others to hold money in British banks, as higher RoR. leads to increased demand for £, so value of £ rises. therefore imports cheaper, exports more expensive, so net trade worsens, AD down.
problems w increased interest rate
- exchange rate may be affected so much, exports fall too much and imports rise too much = balance of trade deficit
- changes take up to 2 years, small changes may not affect consumer choices
- lack of confidence in the economy may mean that no matter what the int. rate is, consumers don’t want to borrow/banks don’t want to lend (AD stays down)
- high int rates for long time will discourage investment, and decrease LRAS
how does QE work?
BoE can ‘buy assets’ by increasing the size of bank accounts at the Bank of England (reserves), which encourages banks to lend as they have more money available.
(EV: However, after financial crisis, BoE found many banks preferred to keep money in reserves instead of lending out so ‘buying assets’ from banks didn’t have desired effect. as a result, Bank bought securities/bonds from priv sector institutions e.g. insurance companies, pension funds and banks)
- since bank buying assets, rise in demand so asset prices rise. +ve wealth effect as shares/houses etc worth more, so people have more disposable income, so spend more (C ↑).
- money supply increases. priv sector companies more money, which can spend on goods + services / other financial assets. (C and I ↑, so AD ↑)
[roblems with QE
- risky and if not controlled can = hyperinflation
- only lead to ↑ demand for second hand goods (e.g. new houses wld be built, but demand ↑ for alr existing 2nd hand houses)
- no guarantee that ↑ asset prices = ↑ consumption (wealth effect)
- can lead to geographical immobility from increased house prices
- potential too dependant on QE? (eurozone)
role of BoE
- keep inflation at 2%, ± 1%. if falls outside this, have to explain why its happened and explain targets to restore this. use CPI to see if target has been met.
- MPC (monetary policy committee) make all important decisions, e.g. BoE base rate and actions over QE
highest revenue raising taxes
- income tax (25% of all tax rev)
- national insurance
- VAT
- corporation tax
problems of fiscal policy
- govt spending also impacts LRAS, e.g. decreased govt spending to reduce AD, govt may be reducing quality of education, or spending on research and tech.
- taxes have impact on inequality, so some taxes to increase/decrease demand may lead to income inequality.
- political issues, e.g. may be unwilling to raise taxes to reduce demand as may lead to being voted out.
- impact of fiscal depends on multiplier. bigger the multiplier, bigger the AD impact is.
eval of demand side policies as a whole
- classical economists, any demand management has no effect on LR output. so supply side policies shld be used. believe that increasing AD will only increase prices.
- on Keynesian LRAS, impact of AD changes depend where economy operating. if at full employment, then rise in AD only higher prices. but if high unemployment, rise in AD only higher output.
- time lags with both
- expansionary brings inflationary, deflationary brings unemployment
monetary vs fiscal
- monetary useful as govt able to ↑ demand without increasing spending (wld = fiscal deficit)
- fiscal significant impacts on supply side, e.g. more spending on education = ↑ AD, ↑ LRAS
more effective for specific groups and reducing poverty, e.g. more benefits = ↑ AD, reduced inequality.
OTHER
- any govt decision will have micro impacts
- e.g. a reduction in tax allows firms to have higher post tax profits, so ↑ investment, ↑ efficiency
causes of great depression
- Wall street crash 1929, sharp fall share prices so loss of money
- loss of consumer and business confidence led to decreased Investment, so downward spiral of AD (multiplier effect)
- US banking system… lent too much in 1920s, so unsustainable boom. govt allowed banks to fail after crash, decreasing confidence further, so less loans to businesses and consumers, fall in AD
- reduction of world trade, decreased AD lowered confidence.
supply side policies to increase incentives
- increased incentive = ↑ size of workforce so greater production of goods/services
- ↓ benefits/taxes will increase opportunity cost of being out of work, so ppl always better in work.
- ↓ benefits may prevent poverty/unemployment trap, where low income workers end up in same/worse position after new job because of lost benefits
- reduction/removal of minimum wage would increase incentive for firms to employ
HOWEVER, tax reduction from 25% to 20% not enough to change ppl working incentive.
reducing tax on high income earners will worsen income inequality, and govt will have less tax rev.
supply-side policies to promote comp
- subsidise new firms
- deregulation: reducing restrictions on businesses which restrict entry to the market
- comp necessary to make firms efficient, as have to offer cheaper/better service if comp.
HOWEVER, deregulation may lead to poorer quality service, or env issues.
supply-side policies to reform labour market
- increasing retirement age, more ppl working so more goods and services produced
- businesses more flexible, e.g. zero hour contracts
- if minimum wage set above equilibrium level, will cause unemployment, so some say minimum wage shld be scrapped, which would increase workers so more quantity
supply-side policies to improve skills + quality of labour
- spending on education and training, so more educated workforce, more efficient and more skilled jobs.
- free uni/spending on secondary etc
- increase in high-skilled migrants, so relax rules for skilled immigration? fills skill shortages in UK
- improvements = more efficient so more output
HOWEVER, may have no effect if skills not relevant to workforce. increasing education will have opportunity costs. time lag as well.
supply-side policies to improve infra
- tax incentives / subsidies on investment, e.g. govt could reduce corp tax
- govt could spend to improve infra (HS2)
- investment = new tech = more efficient, so less resources needed to make same goods, and more tech so more can be produced
- HOWEVER tax breaks etc can harm govt budget, lost tax rev, not all investment successful.
Uk responses to great depression
- balanced govt budget meant UK didnt have to borrow from abroad, so helped exchange rate.
- forced to leave gold standard, so value of £ fell 25% compared to other countries. allowed interest rates to be cut by 2.5%, so AD ↑
USA responses to great depression
- same view initially as uk (balanced budget)
- Roosevelt promised public sector investment, and work schemes for unemployed. Keynesian expansionary fiscal policy, had large impact as US unemployment was very high
causes of globall financial crisis
- mortgage lending: poor people encouraged to take mortgages, given low interest so workers could get bonuses for selling more mortgages. paid for first few years, then couldn’t, so houses repossessed, demand fell, and prices fell, so houses value lower than the mortgage.
- same time, bank grouping ‘prime’ mortgages (likely to pay back) and ‘sub-prime (unlikely to pay back), and selling to other banks as if all prime. led to many having negative assets
- fall in confidence, panic in society as thought banks would collapse, losses for savers
policies to fix global financial crisis
- nationalise banks and building societies, guarantee savers their money.
- expansionary monetary policies w/ record low int rates and QE. lead to lower unemp, higher growth.
- USA more expansionary fiscal policy, maybe why expanded faster. UK prioritised reducing national debt.
evaluation of supply side policies
- can both increase output and decrease prices (unlike demand)
- more long-term policies for LR economic growth
- can be directed @ exports to improve BoP
- HOWEVER, Keynesian LRAS shows they have no impact when LRAS is elastic, so need demand side first to fix problem in SR
- often leads to budget deficit if investing
- time lags (infra and education etc)
econ growth vs environment protection conflict
as economy grows, expect more resources to be used. as resources are used and goods are produced, more pollution and habitats destroyed.
- econ growth in China rapid, but v.high levels of pollution.
econ growth and BoP conflict
India massive econ growth, but country so large that industry mainly producing for own ppl. wealth of ppl ↑ so more demand for imported goods, so BoP worsens
China massive growth, but from producing goods for exports so BoP surplus
unemployment vs inflation conflict
rate of change in money wages increases as rate of unemployment fell
- firms pass on increases in wages to the consumer (increased price)
- firms know if high unemployment, firms can attract workers for low wages. if low unemployment, competing for best workers so offer high wages.
SRPC - short-run Phillips curve
expansionary + deflationary fiscal and monetary policies conflict
- expansionary increase AD, to increase output employment and econ growth, but will increase inflation and maybe worsen BoP as increased demand for goods/services = ↑ imports
- deflationary decrease AD to improve inflation, but decrease employment and econ growth
changes in interest rates policies conflict
- increased IR will decrease inflation. continuously high rates will damage long-term investment as fewer businesses will want to, so decrease LR growth
- also value of £ will rise, decrease X increase M, worsening BoP.
- low IR increase income inequality, richest thokd larger proportion of wealth in non-money assets e.g stocks and shares, so arent affected by int rates. middle and working class more likely to have savings in bank
supply-side policies conflict
- often increase AS, and therefore LR econ growth. can also decrease LR inflation, but may increase SR if encouraged investment as will increase AD.
- policies which decrease trade union power (reduce wages, lower benefits, change tax etc) may increase income ineq. as will -ve affect poorest in country.
- some supply-side have bad effect on budget/environment
fiscal deficits policy conflict
- to reduce fiscal deficit, govt may reduce spending and ↑ taxes. will reduce AD and decrease SR econ growth and higher unemployment
- higher the fall in output as result of measures, higher fall in tax rev, so therefore more ineffective policy
factors contributing to globalisation
- improvements in transport infra: allows quick cheap and reliable methods to allow prod to be located globally
- improvements in IT and comms: co-operate globally
- trade liberalisation: cheaper and more feasible to trade
- international financial markets: ability to raise money and move it around the world
- TNCs: act to max profit, seek cheapest labour globally. produce and sell globally
impacts of globalisation on consumers
- more choice
- lower prices, firms advantage of comparative advantage and produce in country with lowest cost
- rise in price as income is rising so higher demand for goods and services
impacts of globalisation on workers
- job losses in western world as jobs go to cheaper countries
- increased int migration, lowers wages for some but provides skills which increase AD which increase # of jobs
- increased inequality of wages (high skilled wages increasing)
- poor working conditions in sweatshops
impacts of globalisation on producers
- firms can source from more places and sell in more places. reduces risk as a shock in one market will have smaller impact
- low skilled workers much cheaper in LEDC, exploit comp advantage, increased profits
- firms unable to compete internationally will lose out
impacts of globalisation on govt
- higher taxes received, but may lose out as tax avoidance
- TNC have pwr to lobby govt, lead to corruption
impacts of globalisation on env
- increased demand for raw materials, bad for env
- more emissions from increased trade and production
- world can work together to tackle climate change and share ideas/tech
impacts of globalisation on econ growth
- increases investment, TNCs investing is injection
- TNCs bring world class management techniques, can knock on benefit all industries
- trade increases output
- TNCs can cause political instability
- comparative advantage changes over time, companies may leave when country no longer offers advantage. = lots of unemployment, reduces growth
