Unit 2 Flashcards
What is Aggregate Demand?
The combination of ALL products and services in an economy
What is the formula for AD?
C+I+G+(X-M)
C is consumption
I is investment
G is government spending
X is exports
M is imports
What is CONSUMPTION?
Money spent by individuals and families on consumer goods
What affects consumption?
- Disposable Income- An increase in this will increase consumption as people are more willing and able. People may not spend all of it as it depends on Marginal Propentity to save and consume
- Interest Rates- If high then people will save as the reward is higher. If lower then the cost of borrowing is lower so more consumption
- Prices- Movement along the AD curve as consumption has responded to a change in price level
- Consumer Confidence-The future expectations of wealth, income and interest rates
- Wealth Effect- If the value of assets rise then they would be expected to spend and therefore consume more
What is Investment?
Business invest in new stores and new technology
What affects investment?
- Interest Rates- If high then the profitability of the project is lower so it will not be not as viable
- Business Confidence- It is driven by the consumption by consumers as if it is high then more profit is being made and they would be more likely to invest
- Spare Capacity- An increase in demand will lead to more capacity being needed as the current one is full
- Corporation Tax- High rates mean that businesses will make less profits and will be less able and willing to invest
- Advance in Technology- Businesses want the latest most efficient methods so a change in technology will lead to them investing
What affects government spending?
- Size of population- More people will require more public goods
- Shocks- Natural disasters, healthcare, war, economic shocks will lead to the government having to spend money
- Economic Cycle- If a recession then more JSA being paid out as well as benefits. Less tax revenue due to unemployment. Opposite in a boom
- Politics- Certain types of government e.g the conservatives will wnat to spend less money
What affects Imports and Exports?
- Exchange Rate- The value of one currency in terms of another. If the pound is strong then Exports will be expensive and imports will be cheaper. This means that X<m>
</m><li>Incomes Within Trade Partners- Affects the exports as it looks at incomes in the country buying</li><li>Incomes in Home Country- If incomes are high then more luxury products will be wanted from abroad</li><li>Factor Endowment- What the economy has been 'born with'. The natural resources.</li><li>Skills ofWorkforce- Highly skilled workforce leads to more high quality goods being produced</li><li>Protectionism- Restricts trade between countries.</li>
</m>
What is Aggregate Supply?
Cobination of all of the willingness and ableness of business to supply in an economy
Why is the AS diagram curved?
Spare capacity
To begin with business have lots of spare capacity and so are able to supply alot more for a small increase in price so the spare capacity may as well be used
In the end prices will rise quickly and so firms will want to supply more and take advantage of the profits but CAN’T as they have NO spare capacity. They are willing but not able
What affects AS so firms will supply more?
- Increase in Resources- They will have more spare capacity
- Fall In Costs- It means that at a given price there will be more profit made on every unit so they will be more willing to supply more
- Subsidies/ Fall in Tax- Same as a fall in costs
- Increase in Productivity/ Advance in Technology- When output for the same number of workers increases due to more skilles employees or an advance in technology. The items are more profitable so at a given price they are more willing to supply
What is the circular flow of income?
Output generates Income which is spent as Expenditure which requires Output
What is an Injection?
An addition of money to the circluar flow
What are some examples of injections?
Exports
Government Spending
Dis-saving (spending saved money)
Investment
What are leakages?
The removal of money from the circular flow
AKA withdrawal
What are examples of leakages?
Tax
Savings
Imports
What is the multiplier effect?
The final impact on the total value of the circular flow is greater than the initial injection
How does the multiplier effect work?
- Injection of money
- Creates jobs and so wages are paid out extra
- Wages are spent in the local economy
- Creates more income for firms
- Goes round until leakages reduce it to nothing
What are the macroeconomic objectives?
- Economic Growth
- Low Inflation
- Trade Balance
- Low Unemployment
- Sustainable Government Debt
- Fair Distribution of Income
How is economic growth measured?
Expressed as a percentage change in real GDP to make it easier to compare.
What are the problems with measuring economic growth?
- Shadow economy (some income/ expenditure is not included)
- Double counting ( Counting the component and final product)
- Voluntary work
- GDP per capita is only an average
Why do we want economic growth?
- More income which leads to a higher quality of life as more people can afford luxury products
- Increased government spending
- Attracts further investment
- Reduces reliance on other economies
What are the drawbacks of economic growth?
- Inflation- the rise in prices
- Increase in pollution- due to more output and traffic
- Resource depletion- Run out of land and other factors of production
- People are busier- Creates stress and may lead to less family time
What are the evaluation points of economic growth?
- Inflation- May not always be caused due to large amounts of spare capacity
- Pollution- More income which is used to buy new technology but developing countries may not be able to afford them
- Unemployment- People may be made redundant due to firms aquiring new technology
- Higher standard of living- Depends on the distribution of income which means that it may not benefit all
What causes short term economic growth?
A change in demand as it will only go so far until inflation happens and because it doesn’t take a long time to happen.
Eg if income tax decreases then demand would increase quickly
What causes long term economic growth?
A change in supply as more growth will not result in an increase in price and because supply takes a long time to change as factories will have to be built which means it has a lag time
What is unemployment?
When people are out of work and activley seeking employment
What is the rate of unemployment?
The percentage of working age people out of work and actively seeking employment
What is the claimant count?
Calculating the number of people who are claiming Job Seekers Allowance
What are the disadvantages of the claimant count?
- People may not claim due to embarassment or not needing the money
- People can only claim of they have been out of work for over four weeks
What is the Labour Force Survey?
Takes a survey of a large number of people and asks if they are working or not
What are the disadvantages of the labour force survey?
Only an average so it is not very accurate
What are the three types of unemployment?
Cyclical
Structural
Frictional
What is cyclical unemployment?
Demand led which follows the economic cycle. When there is a lot of growth the demand for labour is high so unemployment is low
What is structural unemployment?
People who lack skills to work in jobs with current vacancies.
Eg Bristol dock workers
What is frictional unemployment?
People who are stuck between jobs as they are temporarily unemployed.
What are the effects of unemployment on the individual?
- Low income- low standard of living
- Low self esteem- depression
- Loose skills due to lack of practise- less employable in the future (Hysteresis)
What are the effects of unemployment to society?
- Crime- due to lack of income
- Negative Multiplier- Less consumption
What are the effects of unemployment on the economy?
- Less tax revenue- as fewer people working which means that the government has less ability to correct market failure
- More money spent on Job Seekers Allowance- More pressure on the government
- Government deficit- Less tax+ More JSA
What is inflation?
The general increase in the price level over a period of time
How is inflation calculated?
Using a weighted basket of goods, the Office of National Statistics purchases the basket and calculates the average price. This is then compared with the same time the year before and is expressed as a percentage.
What are the causes of inflation?
- Demand pull- When prices rise due to increased demand for the same quantity of goods which means that people are more willing and able to pay more for them
- Cost push- The costs to businesses increase which means that there is less incentive for them to make profit so they are less willing and able to supply at a given price level.
What are the impacts of inflation?
- Effects household consumption- Assume that wages remain the same which means fewer things can be purchased than before which may reduce their standard of living
- Menu costs- Businesses face these from constantly changing prices. These have opportunity costs as the time could have been spent elsewhere
- Shoe leather costs- The opportunity cost of shopping around for the best price
- Decrease in international competitiveness- Assume no change in the exchange rate, it will take more foreign money to buy a product as it is more expensive at home
What is the difference between real and nominal GDP?
- Nominal GDP does NOT take into account inflation
- Real GDP does take into account inflation
What is the Balance of Payments?
The current account (trade in goods and services, investment income for individuals and transfers) + the Capital account (foreign direct investment where businesses invest their profits in other countries)
For the trade balance what is X and M in (x-m)?
X is money coming to the UK via exports
M is money leaving the UK via imports
When is there a trade defecit or surplus?
Trade Defecit is when X<m></m>
<p>Trade surplus is when X>M</p>
</m>
What are the causes of a trade defecit?
- low quality UK goods- low demand of exports and so x falls relative to m.
- Cost push inflation- costs of businesses increase meaning they will be less willing to supply causing exports to decrease.
- Fall in labour costs in Eurozone- Import costs are less so imports will increase so m>x
- Strong £- Imports will be cheaper and exports will be more expensive so m>x
- Increase in interest rates- foreigners will move money into the UK and it will make the value of the £ increase meaning m>x
- Low productivity in UK- high production costs means international competitivness is lost and so x>m
What are the impacts of a trade deficit?
- Decrease in AD- x-m would be negative
What is government debt?
The accumulation of the previous years deficit and surplus
Deficit- Where government spending> tax revenue
Surplus- Where government spending< Tax revenue
Why is adding to the government debt ok?
- Rising debt is not a concern as the UK has the ability to pay it back
- The size of the debt is a very small percentage of GDP and it is growing at a slower rate compared to the rate of GDP
- Inflation needs to be high as the value of the debt will be eroded away as it is worth less
What are the negatives of a government deficit?
- It is very expensive as interest has to be paid on top of the money owed which means that is has a large opportunity cost
How can the government debt be reduced?
- Borrow less by spending less- Less growth, leads to a lower quality of life, AD will decrease and the multiplier effect will not happen due to less injections
- Increase revenue by increasing tax- Less AD due to less consumption and investment, less of a multiplier effect
What is a fair distribution of income?
An economy where 10% of the people have 10% of the money 50% of the people have 50% of the money …. up to where 100% of the people have 100% of the money which is always true no matter what
What are the problems with inequality of income
- Poverty- Absolue and relative poverty
- Tension in society- People who can’t afford anything will be living with people can afford anything they want
- It can make the problem worse- Poorer children will not do as well at school which limits their employment prospects and leads to further income inequality
- Inheritance- Inequality of wealth (money built up over time)
- Crime- People who can’t afford thing will resort to criminal acts so they can get what they desire
What are the three policies to achieve macro objectives?
- Fiscal
- Monetary
- Supply side
What is a fiscal policy?
Changing
- Tax
- Government spending
What is a monetary policy?
Changing
- Interest rates
- Money supply
- Exchange rates
What is a supply side policy?
- Anything that affects AS
How does a cut in income tax effect growth?
- More disposable income
- Increased consumption
- AD increases as C is a component
- Move up AS curve
- Increased real GDP so growth increases
- Inflation
- Businesses have moved near full capactity so unemployment falls
How does an increase in government spending effect growth?
- Increased government spending
- Increased AD as G is a component
- Increased GPD so growth increases as it shifts to right and moves up AS curve
- More consumption due to multipiler effect
- Inflation
What are the evaluation points of fiscal policies?
- Marginal propentity
- Ceteris Paribus
- Can’t estimate the value of multiplier
- Depends how far up the AS curve
- Assumes AS stays the same
How does a cut in the interest rate work?
- Rewards for saving decreases and there is a fall the borrowing costs
- Mortgage payments fall
- Credit card bills fall
- Marginal propentity to save goes down for extra income
- More disposable income
- Consumption increaes and so does AD
- Economic growth
- Multiplier effect due to more investment from businesses as loan decrease
- G may increase as it is cheaper to run a deficit
What are the evaluation points for a cut in interest rates?
- Ceteris paribus
- Assumes no change in taxes
- Depends on how far up the AS curve
- Marginal propentity
How does a cut in interest rates affect exchange rates?
- Cut in interest rates
- Investors remove their money from your country
- The demand for the £ falls which decreases the price of it in terms of another currency
- The £ depreciates so impots look more expensive and exports are cheaper
- For (x-m) x>m and so AD will increase
- Growth
- Inflation…
What are the evaluation points of the interest rate effecting the exchange rate?
- Investors may not remove money due to no confidence
- Depends on the exchange rate of other countries and so may not change x and m
- Depends on price elasticity of the good
- The exported goods may be low quality and so x may not increase
- Protectionism
- Investors may substitute property investments for cash investments
How is the money supply increased?
- It involves quantitative easing where the Bank of England buy pieces of paper (bonds) from the government which puts money into the government
- This inrease in supply will devalue the currency and will cause the interest rate to fall (price of money) and so people will consume more which will increase AD
What does a supply side policy do?
Attempts to increase AS so firms will be more willing to supply at a given price
How do supply side policies work?
- Increasing productivity- More can be produced with the same resources
- Increasing investment- More capacity and more effective technology
- Improving mobility of labour- Making it easier for people to where there are job vacancies
- Job incentives- Persuade people to work which increases the labour force so wages fall and firms make more profit on every unit
- Invention- Reduced costs so firms are more willing to supply
What are examples of supply side policies?
- Apprentiships
- Start up loans for new businesses
- Wage subsidy
- Benefit Cuts
- Premoting Higher Education
- Free Childcare
- More Housing
- Faster broadband
- Privatise Industries
- Reducing protectionism
What are the evaluation points of supply side policies?
- Assumes ceteris paribus- Benefits of policy may be cancelled out
- Brain drain
- Business start up loans are not effective
- People may not take up subsidies
- Time lags on policies
- People may not use new infrastructure
- Benefit cut will only work if there are job vacancies
- There needs to be demand for more spare capacity
Why do policy objectives conflict?
One single policy is unlikely to achieve all 6 objectives
A compromise is needed to achieve all 6 objectives so multiple policies will need to be used
What is absolute advantage?
When country A can produce at a lower unit cost than country B
What is comparative advantage?
When country A can produce at a lower opportunity cost than B
What does absolute and comparative advantage assume?
That both countries have the same resources
What are the advantages of trade?
- Allows a country to specialise so mopre units will be produced with the same resources
- More production reduces the price so it becomes more affordable
- Improved quality of life
- Better quality products
- Consumers get more choice
Why is protectionism used?
To help stop an economy from losing its international competitivness
What is a tariff?
- Tax on imports
- It is a percentage of the selling price added on to the price of the product
- Imports will fall as producers put their prices up
What is a quota?
- Physical restriction on the number of imports
- Competition is reduced
What are voluntary export restraints?
- When a country asks another to limit the number of exports
- Restricts competition
- Done to repay a favour
What are non tariff barriers?
- Rules/ quality standards that increase the cost of importing by making trade difficult
- The cost is added to the product
What are the effects of protectionism?
On home producers
- Firms put under less pressure
- Less unemployment
On foreign producers
- Products are made expensive so trade is lost
- Lower quality of life
- Can’t grow their business
Consumers
- Increased costs
- Unsafe products
