10 Markers Essay Plans Flashcards
(16 cards)
Causes of a current account deficit (demand side)
A demand side cause of a current account deficit can include strong domestic growth. If this occurs within an economy such as the UK’s, incomes will rise causing there to be a greater disposable income for consumers. This gives consumers a greater incentive to consume, and so the demand for imports such as Cars from Germany will increase. As the import expenditure has increased but not necessarily the export revenue, money flows out to foreign markets and the value of imports exceeds the value of exports so the factors of aggregate demand will decrease causing a shift leftwards (As long as consumption increase has not outweighed the increase in imports) of Aggregate Demand from AD1 to AD2. This results in a current account deficit.
Causes of a current account deficit (supply side)
A supply-side cause of a current account deficit is higher relative inflation in the UK. If other countries such as Germany is to have lower levels of inflation than the UK, the demand for UK exports (worsens export competitiveness) will decrease as they will be of higher value than if they were purchased abroad. It also means that the demand for imports will increase as they will cost less money to domestic consumers than if they were to purchase from the domestic market.This in turn decreases the value of (X-M) components of Aggregate Demand, contributing to the current account deficit as the value of imports exceeds the value of exports.
(Keynesian LRAS with AD shifting left)
Current account deficit definition
A current account deficit occurs when the value of imports of goods, services, income, and transfers exceeds the value of exports, resulting in a net outflow of money from an economy.
Policies to correct a current account deficit (P)
A policy of Protectionism can be used to correct the current account deficit by implementing tariffs. This will reduce the price competitiveness of imports and increase price competitiveness of exports through possible depreciation of the pound. A tariff will increase the world price of a good/service, for example on fast fashion clothing from Shein. If the UK were to impose a tariff on these goods, the value of the goods would increase (as seen in figure one from a shift of the World price curve from World Price to world price + tariff), causing a reduction in imports of them supposing that the price elasticity of demand on these products is elastic. This further reduces the leakages in the circular flow on income - in this context imports. Reducing the number of imports causes a reduction in the current account deficit (as long as there are no retaliation tariffs) as the value of import expenditure may not exceed the value of export revenue as harmfully.
A policy to correct the current account deficit (CFP)
A second policy of contractionary fiscal policy can be used to reduce the current account deficit by increasing taxes. An increase in taxes on households income will reduce their disposable income, making their incentive to spend decrease. This will reduce the demand for imports nationally. As well as cutting Governemnt spending, as government spending is a component of aggregate demand, decreasing this result in AD shifting left making a lower price level and so exports more competitive, export demand will rise and so the current account deficit will improve. This was seen in Greece after the 2008 financial crisis, when Greece cut spending to receive loans from European Commission, the goal being to increase competitiveness for Greece and manage the budget deficit. Both increasing taxes and reducing Government spending will shift AD left, increasing the competitiveness for exports due to a depreciation of the exchange rate making exports cheaper for other countries and improving the current account deficit
Depreciation definition
Depreciation is a general decrease in the value of currency.
One macroeconomic impact of depreciation (N)
One Macroeconomic effect of a deprecation is on the current account, by causing net trade improvements. When a depreciation occurs, imports become more expensive and exports become cheaper. This decreases the demand for imports (as well as import expenditure) such as clothing and raw materials and increases the demand for exports (as well as export revenue). This will result in a higher total value of net exports than net imports, so net exports will rise. As a component of aggregate demand (X-M), the value will rise causing a shift right/increase in aggregate demand. This can be seen in figure 1 from AD1 to AD2, not only increasing real GDP and causing economic growth but also boosting net trade. Although, an improvement in net trade depends on the price elasticity of demand for exports and imports (Marshall Lerner condition), more elastic products will provide greater net trade improvements and an improvement of the current account. This can also generate the multiplier effect as an increase in exports will cause an even larger increase in real national income (GDP).
Second Macroeconomic effect of a depreciation (I)
second macroeconomic effect of a depreciation is on inflation. Depending on the state of the economy, if an economy is close to full capacity then an exchange rate is likely to increase inflationary pressures. A depreciation increases the cost of imports as the value rises compared to other countries so there will be an increase in cost-push inflation, for example, depreciation would increase the cost of raw materials to be imported from overseas countries such as cars from Germany. Deprecation can also increase domestic demand by boosting exports. However, if overseas inflation is low, UK exports become relatively cheaper compared to overseas goods, increasing demand from overseas countries, this may lead to demand-pull inflation. this makes exports more competitive and so may reduce incentives for firms to cut costs and could lead to declining productivity and rising prices in the long-run.
Exchange rate definition
The value of one currency in relation to another
What are tariffs?
Tariffs are taxes imposed by a government on goods and services imported from other countries
What is a maximum price?
Maximum price is a type of government intervention policy that is used to increase the allocation of resources in a market, set below market equilibrium.
How does maximum price affect consumers?
It is used in markets where prices are considered too high, such as rental housing or basic food items.
When a maximum price is introduced below the equilibrium, the price falls, leading to an extension in demand and a contraction in supply. For example, if the price of fruit falls from 50p to 40p, more consumers can afford the good (quantity demanded increases from Q1 to Q2), particularly benefiting those on lower incomes. This increases consumer surplus and improves equity in consumption.
How does maximum price effect producers?
However, the lower price discourages producers, who may reduce the quantity they supply (Q1 to Q3), leading to excess demand or a shortage in the market. This shortage can cause problems such as queues, rationing, or the emergence of a black market, where goods are sold illegally at higher prices. Consumers may also face reduced quality or availability of goods as producers cut costs to maintain profits. In addition to this, producers’ lower prices may reduce revenue and profits, leading them to exit the market or allocate resources to more profitable alternatives. In response, the government may need to subsidise producers or directly provide goods, increasing public spending.
What is a minimum price?
A minimum price is a form of government intervention where the price is legally set above the market equilibrium. An example of this would be in the market of alcohol.
How does a minimum price affect consumers?
This affects consumers as the government would set a minus price legally prohibiting firms from selling below this. A greater quantity of consumers within lower income households will no longer be able to afford these goods such as alcohol, causing a decrease in demand and excess supply (surplus) of alcohol in the market. For example if the price of a certain alcohol such as vodka was minimum £14 per 200ml, a minimum price would raise this price to possibly £16 per 200ml. This decreases equity of consumption as there will be an extension in supply as the higher prices incentivises producers to supply more and a contraction of demand as less there is a reduction in availability of consumers to purchase the good. However, this depends on the level of addiction within society influencing the price elasticity of demand of alcohol, as those with a greater addiction may be less inclined to stop consuming and will be willing to pay a higher price.
How does minimum price affect the government?
This affects the government due to the extension in supply and concern over the outcome for consumers/producers such as black markets or producers becoming forced out of the market. The extension is supply will lead to economic waste if the good/service is not purchased or consumed. The extension in supply can cause wasted stock and will therefore cause the producer to have a loss of profit, potentially forcing them out of the market. An increase in prices may cause the emergence black markets to sell these products at a lower price and make an increase in profit. This will be costly for society as there will be an increase in black market activity, and will cost the Governemnt (therefore the taxpayer) to police. However this does also depend on the elasticity of demand of alcohol as if PED is inelastic, quantity demanded falls very little and so black markets may not emerge as much, making minus pricing more effective.
