MACRO definitions and key evaluations

Question 1

Main macroeconomic objectives

Answer 1

Trade balance- balance on the current account
Price stability - 2% inflation
Economic growth - long run around 2.5%
Minimising unemployment - 3% accounting for frictional unemployment

plus:
Balanced government budget
Greater income equality
Productivity

Question 2

3 tradeoff of falling unemployment with other macro objectives (plus counter arguments)

Answer 2

Balanced government budget. We need to spend more to reduce unemployment. We could cut income taxes to push more into the workforce, but this would mean less revenue
BUT Cutting taxes depends on the laffer curve. By reducing taxes we may be increasing our total revenue. Government spending may be fixed in the long run as we hit an economic peak.
Low inflation The phillips curve shows how reducing unemployment leads to higher price levels, due to greater government spending.
BUT It may be a supply side improvement, which would lower price levels.
Balance of payments on the current account Higher employment will mean higher wages, and a greater amount of spending on imports, especially since the UK’s MPM is high. Inflation will also make our exports less viable.
BUT As more is being imported, UK currency supply would increase in the global markets. This would depreciate the pound, making our exports more competitive

Question 3

3 tradeoff of lowering inflation with other macro objectives (plus counter arguments)

Answer 3

Unemployment The SRPC shows how inflation and unemployment are at odds. If we engage in contractionary monetary policy, C will fall, and therefore AD, but so will Y.
BUT We may have been experiencing stagflation, where AS is inelastic (not much spare capacity) A fall in price level won’t see a significant fall in Y
Economic Growth We will need to slow down economic growth to lower inflation. Contractionary policy will lower PL and AD, but also rGDP
BUT We may grow the economy and lower prices through supply side reform, which will lower AS
Inequality We could engage in austerity and contractionary fiscal policy. The poorest will see their benefits cut, which can further the divide between rich and poor. Contractionary monetary policy is also regressive due to higher interest on loans
BUT The contractionary fiscal policy could be achieved through higher income taxes, especially on higher bands, reducing inflation and inequality.

Question 4

3 tradeoffs of increasing growth with other macro objectives (plus counter arguments)

Answer 4

inflation We may have had expansionary monetary policy, where we have grown AD and rGDP, but also Price Level
BUT We could have been operating way below capacity, so the rise in price level won’t be significant compared to rGDP
balance of payments When real incomes are rising, consumers will tend to import more, worsening the current account position.
BUT We may have grown due to supply side improvements, which would likely see our export competitiveness improve
inequality Economic growth often creates the best opportunities for the more skilled and educated. Those who are not will lag further behind. Benefits may lag behind inflation
BUT wages of the lowest paid may rise faster than the average raise. Government benefits may be in line with inflation, and progressive taxes may reallocate income.

Question 5

What does real GDP measure?

Answer 5

rGDP measures GDP adjusted to inflation. GDP is the measure of the quantity of goods and services produced in the economy

Question 6

What are the 2 main measures of unemployment in the UK?

Answer 6

The Claimant count The number of people claiming unemployment benefits like JSA. They have to prove they are actively looking for work
The Labour Force survey Taken by the ILO. Generally higher as includes people not on benefits such as part time unemployed

Question 7

The 3 accounts on the BoP

Answer 7

Current Account, Financial Account, Capital Account

Question 8

What is GNP

Answer 8

Gross National Product
Market value of all products produced in a year.
GDP + overseas income - income earned by foreigners in the UK

Question 9

The limitations of GDP

Answer 9

No indication of distribution of income
May need to be recalutated in terms of purchasing power
Hidden economies like black market are hard to compare
No indication of welfare

Question 10

The withdrawals from the circular flow

Answer 10

Imports
Savings
Taxation

Question 11

The injections into the circular flow

Answer 11

Exports
Investments
Government spending

Question 12

How much of AD is C as a %

Answer 12

Consumption makes up just over 60% of AD

Question 13

What is the accelerator effect?

Answer 13

The accelerator effect is the relationship between planned capital investment and the rate of change of national income

Question 14

Why does the accelerator effect occur?

Answer 14

1. If firms see a rise in demad and expect this to be maintained, they will soon start to reach maximum capacity
2. To meet future demand they will respond by investing now. A considerable investment outlay may be required
3. Because of economies of scale in investment, it is more efficient to make a significant investment than small annual increases
4. Therefore firms will wait for promising economic conditions before investing

Question 15

Define automatic stabilisers

Answer 15

Policies which offset fluctuations in the economy. These include transfer payments and taxes. They are triggered without government intervention

Question 16

How do exchange rates influence the current account balance? And what does this depend on

Answer 16

A depreciation of the pound means imports are more expensive, and exports are cheaper, so the current account trade deficit narrows
Depreciations make the currency relatively more competitive against other currencies
but this depends on
which currency the pound depreciates against. If it is the dollar or euro, it will have a more significant effect than a country the UK does not really trade with
The demand for UK exports has to be price elastic to lead to an increase in exports

Question 17

What is the mutliplier effect?

Answer 17

The multiplier effect occurs when an initial increase to AD leads to an even bigger increase in national income (GDP)

Question 18

How does the elasticity of SRAS influence the multiplier

Answer 18

When SRAS is elastic, there is lots of spare capacity, so extra output can be produced quickly at little extra cost. The shift in AD will lead to a greater increase to rGDP

Question 19

Formula to calculate Multiplier

Answer 19

1/(1-MPC)

Question 20

How does the strength of the currency affect imports

Answer 20

SPICED
Strong Pound Imports Cheaper Exports Dearer

Question 21

What are shoe leather costs

Answer 21

Consumers face these costs when they have to spend more time and effort finding the best deal while prices are rising

Question 22

What are menu costs

Answer 22

Firms have to keep changing their prices to meet inflation

Question 23

Causes of cyclical instability

Answer 23

Excessive growth in credit and levels of debt Growth that is financed by public debt may not be sustainable. It may be difficult to pay it back in the future and it may not improve productivity
Asset price bubbles. A market bubble occurs when the price of an asset is predicted to rise significantly. It gets traeded more, and demand exceeds supply. Then the bubble bursts and the price steeply falls, causing panic.
Destabilising speculation and animal spirits leads to changes in the price level in a market due to speculation. Assets are bought and sold depending on how they are speculated to appreciate/depreciate. Animal spirits are the instincts and emotions of human nature
Herding act of reacting to other agents rather than the market. Some investors will follow others.

Question 24

Evaluate the claimant count

Answer 24

Not every unemployed person is eligible/even bothers claiming JSA. Those with partners with high earnings do not get to claim JSA. The claimant count generally underestimates the level of unemployment compared to the LFS.

Question 25

Types of unemployment

Answer 25

Structural caused by a long term decline in the demand for a certain industry such as car manufacturing, ship building etc
Frictional is the time between leaving a job and looking for another job.
Seasonal occurs during certain times around the year. Seaside towns will see seasonal unemployment in the winter
Cyclical is linked to a negative output gap, where firms have to lay off workers as consumer spending is low

voluntary people choose not to work. They may be wealthy enough not to work
Real wage wages above market equilibirum (NMW, trade union) may cause unemployment as supply of labour exceeds demand

Question 26

What is the NAIRU

Answer 26

The non accelerating inflation rate of unemployment. It is the lowest unemployment rate that can be sustained without causing wages growth and inflation to rise.

Question 27

How does the exchange rate affect inflation?

Answer 27

If the pound depreciates, then the cost of imports will rise, and the cost of exports will fall. This will mean that (X-M) ^ and therefore AD^

Question 28

What is the Fisher Equation

Answer 28

MV=PT
Money supply x velocity of circulation =
Price level x transactions

T is often subsitituted to Y (GDP)

Question 29

What does the Quantity theory of money argue

Answer 29

Fisher equation argues that increasing the money supply causes inflation.

Question 30

3 Macro tradeoffs from reducing the budget deficit (and counters)

Answer 30

Unemployment will rise if we increase income taxes. More people won’t choose to work as they believe the tax is too much.
BUT we could tackle both by reducing government spending on unemployment benefits. This could push more people into work, and reduce govt budget deficit.
Growth will fall if we lower government spending, as AD will move left, thus rGDP.
BUT we could sell of state industries, reducing the size of the government and improving supply side
Inequality will rise if we choose to reduce spending on benefits
BUT we could use progressive taxation and tax the richest more, shrinking the inequality

Question 31

3 macro tradeoffs from balancing the current account (with counter)

Answer 31

inflation In order to improve the current account position, X will have increased and M will have decreased. This will rise AD, thus increasing PL
BUT we could improve the supply side. SRAS could improve as our industries are exporting, and PL will fall, as well as X will increase

budget deficit The government will have had to invest heavily in our export sector, which will have further increased the budget deficit
BUT in order to reduce imports, tariffs can be implemented and raise govt rev.
inequality Prices will rise due to inflation, tariffs and quotas.. Vegetables are mostly imported. If we choose to tariff spanish oranges, polish potatoes etc, then prices will rise, hitting the poorest hardest. Regressive.
BUTwe can choose to invest in domestic industries. This will reduce the price of UK goods, which will mean more can shop domestically and M will fall, while prices also fall

Question 32

Effect of Low Interest on Govt Spending

Answer 32

Lower interest rates mean government debt repayments will be lower, and it will encourage the government to issue more bonds to contribute to higher levels of government spending.

Question 33

Explain how QE works

Answer 33

1. The B of E buys government bonds, injecting bank reserves into the economy
2. Increasing the supply of money will lower interest rates further and provide liquidity to the banking system
3. It is used when standard monetary policy is no longer effective, (base rate is as low as it can go)

Question 34

Limitations of QE

Answer 34

• The supply of the £ will increase. This will mean a depreciation on FOREX markets. This will make exports more competitive but imports dearer - possible cost push inflation
• QE lowers long term interest rates as the money supply has increased. This makes bonds less attractive to potential investors, as their ROI is lower, so investment falls, thus LRAS.

Question 35

Factors considered by the MPC when setting the bank rate

Answer 35

• Unemployment rate If unemployment is high, then consumer spending is low. This suggests MPC should drop interest rates
• Savings rate If there is a lot of saving, consumers are not spending much. Interest rates could fall.
• Consumer spending If consumer spending is high, then this could be inflationary. This would cause MPC to raise interest rates
• High commodity prices Since the UK imports commodities like Oil, cost push inflation could occur, meaning interest should be raised to counter it
• Exchange rate A weak pound will cause PL to increase. This makes X relatively cheap, so X will increase

Question 36

The 4 functions of money

Answer 36

• A medium of exchange. Without money transactions were conducted through bartering. Differences in value meant that a trade couldn’t be made. Money eliminates this problem
• A measure of value (a unit of account) Money provides a means to measure the relative values of different goods and services. Jewellery will have a higher value than an apple
• A store of value Money has to hold its value to be used for payment. It can be kept for a long time without expiring.
• Method of deferred payment Money can allow for debts to be created. People can therefore pay for things without having money in the present and pay for it later

Question 37

Define money supply

Answer 37

The money supply is the stock of currency and liquid assets in an economy. It includes cash and money held in savings accounts

Question 38

Define narrow money

Answer 38

Narrow money is the physical currency (notes and coins) as well as deposits and liquid assets in the central bank

Question 39

define Broad money

Answer 39

Broad money includes the entire money supply. Cash could be in restricted accounts, which makes it hard to calculate money supply. It includes liquid and less liquid assets

Question 40

Explain the difference between the money market, capital market and FOREX market

Answer 40

• In the money market liquid assets are traded. It is used to borrow and lend money in the short term
• The capital marketis where equity and debt isntruments are bought and sold.
• The foreign exchange market is a market where currencies are traded, mainly by international banks. It determines what the relative value of different currencies will be

Question 41

The role of financial markets in the wider econonmy

Answer 41

• To facilitary saving - provide somewhere for consmers and firms to store their funds
• To lend to businesses and individuals
• To facilitate the exchange of goods and services The transfer of resources is facilitated by a way that buyers and sellers can interact and transfer funds
• To provide forward markets in currencies and commodities In commodity markets investors trade primary products. Forward markets are informal financial markets where future contracts are made
• To provide a market for equities Equity markets involve the trade of shares. AKA the stock market

Question 42

Explain the difference between debt and equity

Answer 42

Debt is money which has been borrowed from a lender, which is usually a bank. There is little flexibiliity and the loan is later repaid with interest

Equity is a stock or security which represents interest in owning, eg a firm, car, house. There is no outstanding debt and can be sold for cash.

Question 43

Explain why there is an inverse relationship between market interest rates and bond prices

Answer 43

Bonds compete against each other on the interest income they provide to make them seem attractive to investors. When interest rates go up, newer bonds have higher interest rates so existing fixed-rate bonds must sell at a discount to compete

Question 44

How do firms raise finance

Answer 44

issuing shares, issuing corporate bonds, borrowing from a bank

Question 45

What does the term coupon mean in terms of govt bonds

Answer 45

An interest payment to the bond holder between the date of issue and the date of maturity

Question 46

Explain the difference between a commercial bank and an investment bank

Answer 46

A commercial bankmanages deposits, cheques and savings accounts for individuals and firms. They can make loans using the money saved with them.
Investment banks facilitate the trade of stocks, bonds and other forms of investment. Government regulation is weaker in the investment bank industry, and this combined with their business model gives them a higher risk tolerance.

Question 47

What are the main functions of a commercial bank?

Answer 47

• Accept deposits from the public, usually in the form of savings. Fixed deposits have the highest interest as the bank can use thesek knowing they won’t be withdrawn
• Provide loans The main source of income for commercial banks is interest, which banks earn through providing loans. Banks create credit by using deposited funds as loans.
• Overdraft is when a current account has no deposits, consumers can still borrow money from the bank in the form of an overdraft. These are high interest and only a limited amount can be borrowed
• Investments of Funds. Surplus funds could be invested into securities such as government bonds and treasury bills. These could earn a return for the bank
• Agency functions Banks represent their customers. Eg, they collect cheques and dividends, pay and accept bills such as through direct debit, deposit interet and income tax, buy and sell securities and arrange the transfer of money between places

Question 48

What are the main functions of a commercial bank?

Answer 48

• Accept deposits from the public, usually in the form of savings. Fixed deposits have the highest interest as the bank can use thesek knowing they won’t be withdrawn
• Provide loans The main source of income for commercial banks is interest, which banks earn through providing loans. Banks create credit by using deposited funds as loans.
• Overdraft is when a current account has no deposits, consumers can still borrow money from the bank in the form of an overdraft. These are high interest and only a limited amount can be borrowed
• Investments of Funds. Surplus funds could be invested into securities such as government bonds and treasury bills. These could earn a return for the bank
• Agency functions Banks represent their customers. Eg, they collect cheques and dividends, pay and accept bills such as through direct debit, deposit interet and income tax, buy and sell securities and arrange the transfer of money between places

Question 49

Distinguish between assets and liabilities

Answer 49

Assets are owned by the bank
Liabilities are owed by the bank

Question 50

What are the 6 characteristics of money

Answer 50

Acceptable
Portable
Durable
Divisible
Limited
Difficult to forge

Question 51

What does it mean if an asset is liquid?

Answer 51

It can easily be acquired or disposed of without high costs and with relative certainty as to its value