Unit 2.2

Question 1

Aggregate demand

Answer 1

the total demand for goods and services within a country. Measures spending on goods and services by consumers , firms, government and overseas consumers.
AD = C + I + G + NX
AD= (consumers) + (investment) + (government) + ( Net exports)

Question 2

Consumer spending

Answer 2

Amount consumers spend on goods and services, this is the biggest contributor of AD

Question 3

Investment

Answer 3

Investment/ spending from businesses, mostly from private sector businesses. Investment is spending which adds to the capital stock ie can only be used to increase output in the economy.

Question 4

Government spending

Answer 4

This is how much the government spends on goods and services such as schools, hospitals, benefits, defence etc

Question 5

NX ( exports - imports)

Answer 5

This is known as Net exports and is the value of the current account on the balance of payments ( we are in a deficit so this reduces AD)

Question 6

Interest rate effect on AD

Answer 6

If I/r increase then investment and consumer spending decreases so AD decreases

Question 7

Movement along the AD curve

Answer 7

If there is a fall in price level there is an extension in demand, if there is increase in price there is a contraction in demand.

Question 8

Movement and Shift in the AD curve

Answer 8

If price changes in an economy (and nothing else) there will be a movement along the AD curve. If any of the components change then there will be a shift in the curve. Shift left ( inwards) if components decrease, Shift right ( outwards) if components increase

Question 9

Reasons for shifts in the curve ( assuming price level is the same)

Answer 9

-Higher confidence levels amongst businesses will encourage more investment
-The wealth effect- most people in the UK own their own houses, so if house prices increase, they feel wealthier and so they spend more
-Bank of England decides to decrease interest rates. This lowers the cost of borrowing , decreases the incentive to save and lowers mortgage payments for homeowners. All these can result in increased consumptions.
-Decrease in tax rate means more disposable income which shifts AD to right
-An increase in government spending shifts AD to the right
-Weakening pound means we export more and shifts AD to right

Question 10

factors affecting consumer spending

Answer 10

1. Real disposable income
2. Household wealth including house prices
3. Unemployment / job security
4. Interest rates paid on loans and savings
5. Availability of credit finance
6. Consumer confidence / animal spirits

Question 11

propensities to spend and save

Answer 11

*Disposable income can be spent or saved
* Marginal propensity to consume (MPC)
* Marginal propensity to save (MPS)
* MPC + MPS = 1
* A rise in the marginal propensity to save implies a lower marginal propensity to spend

Question 12

How lower interest rates can increase aggregate demand

Answer 12

A fall in interest rate on a property mortgage means that home buyers have less to pay each month paying the interest on a home loan. This means they have a higher effective disposable income which can be spent on goods and services. Another effect of lower interest rates is usually to lower the cost of servicing a credit card to other types of borrowing. And it also reduces the incentive to save, especially if nominal interest rates on savings are below the rate of inflation. Through these channels, lower interest rates can be expected to lift consumer demand which is the largest component of AD. Cheaper loans might also lead to a rise in planned capital investment spending by businesses which is also a component part of AD.

Question 13

Disposable income

Answer 13

The amount consumers have left over after taxes ; they can choose to spend or save this money.

Question 14

Where does income for consumption come from

Answer 14

• Wages
  -Pension
• Investment
  -The wealth effect - assets rising in value

Question 15

Marginal propensity to consume

Answer 15

MPC: Refers to how much a consumer changes their spending following a change in income.
For individuals the MPC could be greater than 1 if they borrowed money to consume. For the economy as a whole the MPC is likely to be positive but less than .
= change in total consumption / change in income

Question 16

Marginal Propensity to save

Answer 16

MPS: How much consumers change their saving following a change in income.
=change in total savings / change in income

Question 17

MPC formula

Answer 17

Positive means a rise in income will increase consumption
Change in consumption/ change in income

Question 18

Average Propensity to consume

Answer 18

APC: Measures the average amount spent or consumed out of total disposable income in an economy
Consumption (C) / Income (Y)

Question 19

Other factors affecting C

Answer 19

-The availability and cost of credit - regulations on borrowing money can increase or decrease the level of consumption. Changes in i/r can make it cheaper / more expensive
-Expectations - If people expect a downturn in the economy to a period of slow growth they may save more
-Confidence - If consumers expect to be promoted in the future or are secure and know there are lots of jobs prospects
-Asset prices - changes in the value of shares or houses can influence spending decisions ( the wealth effect)

Question 20

Time Lags In C

Answer 20

• A fall in Income ( Y ) might not immediately feed through to a fall in C
  -Changing interest rates ( i/r ) won’t change C straightaway

Question 21

Examples of Capital investment

Answer 21

-Robotics
-Integrated Plant
-Machine tools
-Infrastructure
-Software
-Logistics

Question 22

Factors Influencing Planned business investment

Answer 22

-Actual and expected demand for goods and services
-Expected profits and business taxes
-Intrest rates + availability of business finance
-Business confidence i.e. animal spirits

Key points:
-Government can lift investment by lowering corporation tax or offering other tax incentives as part of their fiscal policy
-Planned investment tend to rise when firms expect rising demand and have limited spare capacity to supply goods and services.

Question 23

Explaining the basic accelerator effect - examples

Answer 23

-Investment to expand the fleets of delivery companies as online spending surges
-Rising capital investment in renewable energy as energy supply shifts towards renewable

Question 24

animal spirits

Answer 24

John Maynard Keynes coined the notion of animal spirits which refers to a mix of confidence, trust, mood and expectations
When confidence is low, individuals save more, businesses save more too and because demand and profits lower than expected , they cut back on production and prehaps postpone or cancel capital investment projects.

Question 25

Significance of investment for the Economy

Answer 25

-Injection of demand for capital goods and industries
-Investment can lift productivity/ incomes
-economies of scale and better competitiveness
-Investment helps to sustain export- led growth

Question 26

The Basic accelerator effect

Answer 26

• The accelerator effect is a positive relationship between planned capital investment and the rate of change of national income
• Consider an industry (sector) where demand is rising quickly
• Firms may respond initially by using their existing capacity more intensively or running down stocks of finished products
• If they expect high demand will be sustained - they may increase spending on plant and machinery, factories and new technology to increase their supply capacity
• This causes a positive accelerator effect - a rise in demand for consumer goods and services will cause a bigger percentage change in demand for capital goods

Question 27

Gross Investment

Answer 27

Gross investment is the total amount that the economy spends on new capital. This figure includes an estimate for the value of capital depreciation since some investment is needed each year just to replace technologically obsolete or worn-out plant and machinery.

Question 28

Net investment

Answer 28

Net investment = gross investment -
capital depreciation.
If gross investment is higher than depreciation, then net investment will be positive. This means that businesses will have a higher productive capacity and can meet rising demand in the future.

Question 29

Difference between savings and capital investment

Answer 29

Savings represent the total amount of income that is not consumed by households, businesses, or the government.
Capital investment is spending on machinery, equipment, factories, technology & infrastructure to create new capital goods.

Question 30

Main components of government spending

Answer 30

-Welfare spending ( transfer payments)
-Public spending ( recurring spending )
-State investment ( investment projects)

Question 31

What is the difference between the current and capital spending by the government

Answer 31

Current government spending- on providing public services
* Salaries of NHS employees
* Drug used in healthcare
* Road maintenance budget
* Army logistics supplies

Capital spending - investment in new public infrastructure
* Construction of new motorways and bridges
* New equipment in the NHS
* Flood defence schemes
* Extra defence equipment

Question 32

Government spending and aggregate demand

Answer 32

-Increase in Aggregate Demand: When the government increases its spending on goods, services, infrastructure projects, or social (welfare) programmes, it injects money directly into the economy.
-Offsetting Economic Declines: During a recession, by increasing its own spending, the government can help stimulate economic activity, preventing a more severe downturn. This is known as a fiscal stimulus.

Question 33

Exporting

Answer 33

exporting is the act of selling goods and services to another country. Income from exports counts as an injection into the circular flow of income and adds to aggregate demand (AD)

Question 34

Trade Balance

Answer 34

The trade balance is the difference between the value of exports and imports. When the value of exports is greater than the value of imports, the trade balance is in surplus. When the value of imports is greater than the value of exports, the trade balance is in deficit.

Question 35

Factors influencing exports of goods and services

Answer 35

-Relative prices of exports in world market
-The exchange rate - a stronger currency makes exports more expensive
-Non price demand factors e.g. Design and Branding
- Strength of Aggregate demand in key export markets

Question 36

Aggregate Supply

Answer 36

AS- The total amount that producers in an economy are willing and able to supply at a given price level in a given time.

Question 37

Short term aggregate supply

Answer 37

The SKAS is defined as being the total supply in an economy when 1 factor of production is fixed.

Question 38

The aggregate supply curve

Answer 38

The aggregate supply curve is upward sloping because at a higher price level, producers are willing to supply more as more profits can be earned

Question 39

What shifts AS curve in short run (affects cost of production)

Answer 39

-Cost of labour- increase in wages, employment taxes, employment regulation …. leads to increased costs, therefore firms less willing and able to supply.
-Cost of commodities/ raw materials - rising costs such as increasing energy costs will decrease the amount supplies are willing and able to supply
-Exchange rates - If pound weakens in value against other currencies. The price of imports will be higher resulting in increased costs of imported component parts.
-Changes in productivity- Increased productivity leads to lower costs so suppliers are willing and able to supply more
-Taxation/ regulation- increase in tax would mean higher costs for suppliers therefore less willing and able to supply
-Technological advancements (SR and LR) - leads to more efficient production therefore increasing the amount suppliers are willing and able to supply.

Question 40

Macroeconomic equilibrium

Answer 40

Macroeconomic equilibrium for an economy in the short run is established when AD intersects with SRAS. If increase in AD only this will lower inflation and increase GDP. This equilibrium determines the general price level and real GDP level. Changes (shifts) in SRAS and for AD will being about a change in the equilibrium.

Question 41

Explain the shape of the keynesian AS curve

Answer 41

-When spare capacity is high, aggregate supply will be elastic: this means that a rise in aggregate demand can be met easily by increased output and there is little threat of rising prices (inflation)
-The elasticity of the curve falls as a country moves through an economic cycle:
1.The amount of spare capacity declines
2.There is the possibility of diminishing returns in production
3.Bottlenecks appear in the supply of key inputs including skilled labour
-When AS is perfectly inelastic, an economy is at full capacity (equivalent to being on the PPF boundary); this means that further increases in AD are purely inflationary in the short run with little extra real output

Question 42

Keynesian Aggregate Supply Curve

Answer 42

The Keynesian aggregate supply curve is non-linear where the elasticity of aggregate supply is dependent in part on the level of spare productive capacity at different stages of a nation’s economic cycle.
At first the line is horizontal- perfectly elastic portion of the AS curve
Then it begins to bend upwards- Elasticity of aggregate supply now starting to drop as economy heads towards productive capacity
Finally it is vertical - Elasticity of supply is zero when full capacity is reached

Question 43

Keynesian Aggregate Supply Curve - Non-inflationary growth

Answer 43

An outward shift in AD from AD1 to AD2 can be met without an increase in the general price level because aggregate supply is highly elastic

Question 44

Keynesian Aggregate Supply Curve - Inflationary pressures from rising AD

Answer 44

Here, an outward shift in AD from AD3 to AD4 causes a sharp rise in the general price level because AS is now inelastic - output is close to full-capacity levels

Question 45

Long run aggregate supply

Answer 45

Long run aggregate supply (LRAS) represents the maximum possible output; it is like a country’s PPF. It represents that maximum output when all factors of production are fully and efficiently employed.

Question 46

Labour productivity

Answer 46

A measure of efficiency indicated by output per person employed or value of output per hour worked.

Question 47

Infrastructure

Answer 47

Infrastructure includes physical capital such as transport networks, energy, power and water supplies and telecommunications networks

Question 48

key factors influencing long run aggregate supply

Answer 48

-Higher Productivity of Labour and Capital - I.e. a rise in output per person employed or the increased efficiency of technology
-Growing Population & Increased Labour Market Participation - i.e. A growing labour supply and a rise in the number of people in paid work
-Innovation and Enterprise- Product and process innovation from research and development and higher rate of increase of business start-ups
-Capital Investment - Including capital spending by businesses, inward investment (FDI) and the Public Sector (Government)
-Stock of natural (environmental resources)-e.g. renewables, stocks of natural resources

Question 49

key factors influencing long run aggregate supply- changes in a nations potential GDP

Answer 49

Changes in a nation’s potential GDP are largely brought about by:
1.Changes in labour supply available for production (i.e. more people joining the labour force)
2.Changes in the stock of capital inputs including infrastructure
3.Changes to the stock of natural resources
4.Changes in the efficiency of allocation of factor inputs e.g. shifting resources from rural to urban areas
5.Improvements in the quality of inputs / productivity
6.Advances in the state of technology (web, AI, renewables)
7.Improvements in institutions such as banking/legal system

Question 50

Shift in the long run aggregate supply curve

Answer 50

-An outward shift of LRAS signifies an increase in potential output and employment and signifies real economic growth
-In the long run, the ability of an economy to produce goods and services to meet demand is based on the state of technology and the availability and quality of factor inputs.

Question 51

Importance of infrastructure for developments

Answer 51

Off-grid renewables
Transport infrastructure
Mobile money systems
Drone technologies to improve health care
Improved irrigation in farming
Border infrastructure
Basic sanitation
Waste disposal systems

Question 52

Circular Flow of Income

Answer 52

A model of the economy which shows the movement of goods and services between households and firms and their corresponding payments in money terms

Question 53

National Output (O)

Answer 53

The value of the flow of goods and services from firms to households

Question 54

National Expenditure (E)

Answer 54

The value of spending by households on goods and services

Question 55

National Income (Y)

Answer 55

The value of income paid by firms to households in return for land, labour and capital

Question 56

Injections and Withdrawals

Answer 56

-Injection - this is the spending in the circular flow that does not come from households. There are three sources of injections:
1. Investment
2. Government spending
3. Exports

-Withdrawals (or leakage) - there are 3 sources of withdrawals to correspond to the three injections:
1.Saving by households
2.Taxes
3.Imports

Economic equilibrium when injections = withdrawals

Question 57

Government budget deficit

Answer 57

When the government is spending more than they receive in tax, this is a budget deficit. (not a current account deficit)

Question 58

Supply-side policies

Answer 58

Supply-side policies are a set of economic measures and strategies that aim to improve the long-run productive capacity and efficiency of an economy.
The primary goal of supply-side policies is to stimulate long-term economic growth, increase productivity, and create a more favourable environment for businesses to operate

Question 59

Main Aims of Supply-side policies

Answer 59

1.Improve incentives to work and invest in people’s skills (human capital)
2.Increase labour and capital productivity
3.Increase occupational and geographical mobility of labour
4.Increase capital investment and research and development spending
5.Promote contestability and stimulate innovation (dynamic efficiency)
6.Encourage start-ups and expansion of new businesses especially those with significant export potential / promote economic diversification
7.Improve price & non-price competitiveness in global markets
8.Improve the trend rate of sustainable growth of real GDP to help support improved living standards & better regional economic balance

Question 60

Main UK supply side weaknesses

Answer 60

-Low R&D spending - 1.74% of GDP in 2019, lower than in comparable countries like the US (3.1%) and Germany (3.2%).
-Low Investment - Business investment fell to just 10% of GDP in 2020. Overall, UK investment is lower than OECD average
-Skills shortages - 1.3 million job vacancies. Reported that by 2024 there will be a shortfall of four million highly skilled workers
-Economic inactivity- 400,000 rise in economic inactivity since 2020. Inactivity now 20% of the population of working age.
-Low labour mobility - Low housing affordability (to buy and rent) and structural barriers to social mobility. In 2021, only 6,000 new social housing units supplied in UK.
-Ageing infrastructure- 5 million homes at risk of flooding. Major rise in serious pollution incidents from water/sewerage.
Inadequate transport network
-Regional economic imbalances- GDP per head (2019, £)
London: £56,199
Northeast: £24,068
UK: £33,151
-Productivity Gap-In 2019, ranked on GDP per hour worked, the UK came fourth highest out of the G7 countries. UK productivity 15% below the US & France

Question 61

What is the likely impact of a government deficit on the circular flow of income

Answer 61

Budget deficit refers to government spending which is greater than government revenue ie from taxation. The budget deficit is a net injection as there is more money flowing around the circular flow, therefore AD increases

Question 62

Output Gap

Answer 62

The output gap is the difference between the actual level of GDP and its estimated potential level.
The output gap is usually measured as a percentage of the level of potential output.

Question 63

Negative Output Gap

Answer 63

-A negative output gap refers to a situation where an economy’s actual output or real gross domestic product (GDP) is below its potential output.
-Potential output represents the level of production an economy can achieve when all resources (labour, capital, technology) are fully employed without causing inflationary pressures.
-When actual output falls below this potential level, it results in a negative output gap.
-A negative output gap often corresponds to higher unemployment and under-utilized resources. It might also lead to disinflationary effects

Question 64

Positive Output Gap

Answer 64

-In economics, a positive output gap refers to a situation where an economy’s actual output or real gross domestic product (GDP) exceeds its potential output.
-Potential output represents the level of production an economy can sustainably achieve when all available resources (labour, capital, technology) are fully utilized without causing inflationary pressures.
-When actual output surpasses this potential level, it results in a positive output gap. This can lead to rising demand-pull and cost-push inflationary effects.

Question 65

Multiplier Process

Answer 65

• The multiplier effect happens where an initial change in spending, whether it’s from consumers, businesses, or the government, leads to a larger and more widespread final impact on an economy’s total output or income.
  *The multiplier effect illustrates how changes in spending can create a ripple effect throughout the economy, generating additional rounds of economic activity.
• When an individual increases its spending, the recipients of that spending then have more income, which they, in turn, spend on goods and services.
• This creates additional demand, which prompts businesses to increase production and hire more workers, resulting in higher factor incomes.

Question 66

Multiplier Process Examples

Answer 66

The government injects £200m in a project to build thousands of affordable new houses. This is an expansionary fiscal policy designed to stimulate aggregate demand and economic growth.

-A new house building project injects £200m of extra demand and output into the economy
-Many businesses benefit directly including building supply industries, architects etc.
-Constructing new houses generates a new flow of factor incomes - including wages and profits
-Will the extra incomes stay inside the circular flow of income and spending? This is key!
-If so, the multiplier effect is likely to be strong and resultant final impact on GDP quite large

Question 67

The Multiplier

Answer 67

The multiplier is defined as the final change in equilibrium national output resulting from an initial change in AD.

Question 68

Positive Multiplier effect

Answer 68

when an initial increase in an injection ( or a decrease in a leakage) leads to a greater final increase in the level of real GDP

Question 69

Negative Multiplier effect

Answer 69

When an initial decrease in an injection (or an increase in a leakage) leads to a greater final decrease in the level of real GDP.

Question 70

Formula for the multiplier in a closed economy with no government

Answer 70

Multiplier = 1 / marginal propensity to save

-we know that the MPTC and TS must equal 1
-Disposable income can be spent or saved
-MPS + MPC = 1, therefore MPS = 1- MPC
-therefore the multiplier formula can be written as:
Multiplier = 1 / (1-MPC)

Question 71

Formula for multiplier in open economy with a government sector

Answer 71

Multiplier = 1 / MPS + MPM + MRT

In an open economy with a government sector, there are 3 withdrawals from the circular flow:
1. Savings ( marginal propensity to save)
2. Imports ( marginal propensity to import)
3. Taxation ( marginal tax rate on income)

Question 72

What Factors Affect the Multiplier value

Answer 72

*Marginal Propensity to Consume (MPC): A higher MPC leads to a larger multiplier effect because a greater proportion of any initial increase in income is spent, leading to multiple rounds of increased spending and output.
*Leakages: Leakages from the circular flow, such as saving, taxes, and imports, reduce the size of the multiplier. If people save a significant portion of their additional income, or if a substantial portion of the increased spending leaks out of the economy in the form of taxes or imports, the multiplier effect will be smaller.
*Degree of Spare Capacity: If an economy is operating close to its full potential (with little
spare capacity), the multiplier effect might be limited.
* Time Frame: In the short run, factors like capacity constraints and rigidities in adjusting production can limit the multiplier’s size. In the long run, adjustments in production capacity, investments, and resource allocation can lead to a larger multiplier effect.

Question 73

High and Low values for the multiplier

Answer 73

High Multiplier value when:
-Economy has plenty of spare capacity (a
negative output gap) to meet higher
aggregate demand
-Marginal propensity to import and tax is low (important leakages)
-High propensity to consume any extra
Income (people have a low marginal propensity to save)

Low multiplier value when:
-Economy is close to capacity limits during a boom phase of an economic cycle
-Propensity to import goods and services is high- this means extra demand leaks from circular flow
-Higher inflation causes rising interest rates which then dampens the other components of AD

Question 74

Multiplier and elasticity of Aggregate supply

Answer 74

When SRAS is highly elastic, the multiplier effect is likely to be
high following an increase in an injection of demand.
When SRAS is inelastic, it is
harder for supply
to expand to meet a rising level of AD

Question 75

Economic growth

Answer 75

Economic growth is defined as the increase in the real value of goods and services produced as measured by the annual percentage change in real Gross Domestic Product (GDP).
Economic growth is also defined as a long-run increase in a country’s productive capacity / potential national output.

Question 76

Actual growth

Answer 76

Actual growth refers to the real increase in an economy’s GDP over a specific period. Actual growth reflects the economy’s current performance and considers factors such as changes in consumer spending, business investment, government spending, and net exports

Question 77

Potential growth

Answer 77

Potential growth refers to the economy’s maximum sustainable rate of expansion without generating inflationary pressures. Potential growth is determined by the economy’s productive capacity, which is influenced by factors such as technological progress, labour force growth, and capital accumulation

Question 78

Potential Output

Answer 78

Potential output refers to an economy’s productive capacity in a physical sense. It is the largest output that could be produced, given the prevailing state of technology and stock of available resources. An increase in potential output signifies long-run economic growth.

Question 79

Trend growth

Answer 79

Trend growth is the long term non-inflationary increase in GDP caused by an increase in a country’s productive capacity. The trend rate of economic growth is the average sustainable rate of economic growth over time

Question 80

Drivers of short term economic growth

Answer 80

-Expansionary monetary policy such as lower interest rates and quantitative easing
-Expansionary fiscal policy including direct & indirect tax cuts and increased government spending and borrowing
-Depreciating exchange rate helping to boost exports of goods and services (X)
-Strong growth of asset prices such as property and shares
-Expanding employment and rising real incomes for those in work
-Improved business confidence driving higher capital investment
-Increased export sales from a boom / recovery in countries that are major trade partners perhaps aided by free-trade deals

Question 81

Short term economic growth- key factors

Answer 81

-Changes in interest rates set by the central bank
-Commodity prices such as oil, gas and food
-Currency changes affect demand for exports and imports
-Confidence of businesses and households
-Recovery from an external shock such as the pandemic
-Fiscal policy- changes in government spending and taxation

Question 82

How to show short term growth

Answer 82

-Shifts within the PPF graph
-Shift of AD along SRAS on AD-AS graph

Question 83

Long term economic growth

Answer 83

Long-run growth is a sustained increase in a country’s productive capacity.
Long-run economic growth implies a consistent and prolonged expansion of an economy’s output, rather than short-term fluctuations or temporary increases in economic activity.
The main drivers of long-run growth are improvements in productivity and a growing labour supply alongside the benefits of technological change
Long-run growth can include shifts in the composition of industries, improvements in technology, increased human capital, and advancements in a country’s essential infrastructure.

Question 84

Long term economic growth- key factors

Answer 84

-Investment in capital including essential infrastructure
-Improved labour productivity
-A growing labour supply
-Higher research and development spending
-Growth that flows from successful innovation
- Enterprise- a growing number of business start-ups.

Question 85

Main drivers of long run economic growth

Answer 85

-Impact of a rise in investment which can increase a nation’s productive capacity
-Expanding population and active labour supply – perhaps due to net inward migration
-Rise in labour productivity such as an increase in GDP per hour worked
-Growth spillovers (benefits) from invention and innovation
-Growth spillovers from increased government spending on public goods and other essential infrastructure
-Growth potential from business start-ups / entrepreneurship
-New resource discoveries including natural resources

Question 86

How to show long run economic growth

Answer 86

Shift in PPF outwards
Shift in LRAS to the right on AD-AS graph
Outward shift of AS on Keynesian aggregate supply curve

Question 87

Main benefits of Economic Growth

Answer 87

1.Higher living standards – i.e. Real GNI per capita – helps to lift people out of extreme poverty and improve development outcomes (e.g. rising HDI)
2.Employment effects – sustained growth stimulates jobs and contributes to lower unemployment rates which is turn helps to reduce income inequality.
3.Fiscal dividend – higher economic growth will raise tax revenues and reduce government spending on unemployment & poverty related welfare benefits
4.Accelerator effect - rising growth stimulates new investment e.g. in low-carbon technologies. Better growth may attract foreign direct investment projects

Question 88

Main Costs of Economic Growth

Answer 88

1)Risks of higher inflation and higher interest rates
-Fast-growing demand can lead to demand-pull and cost-push inflation – this leads to a conflict between macro objectives
-The central bank may decide to raise interest rates to control inflation
2)Environmental effects
-More negative externalities such as pollution & waste
-Risk of unsustainable extraction of finite resources – i.e. fast growing countries may cause a long-run depletion of natural resources
3)Inequalities of income and wealth
-Rapid increases in real national income can lead to a higher level of inequality and social divisions
-Many of the gains from growth may go to only a few people

Question 89

export led growth

Answer 89

Export-led economic growth is a development strategy in which a country focuses on increasing exports as a driver of expansion.
This approach involves producing goods and services that can be sold in international markets, with the goal of earning foreign exchange and stimulating economic activity.
The revenue generated from exports can then be used to finance imports, invest in infrastructure, and support domestic industries

Question 90

High Trade to GDP ratios

Answer 90

A substantial number of countries have a high trade-to-GDP ratio. This ratio measures the combined value of exports and imports of goods and services, expressed as a % of their national output.
Ireland 227%
Singapore 337%
In 21/22

Question 91

Key features of Export led growth

Answer 91

Specialisation: Countries often specialise in producing goods and services in which they have a comparative advantage. This means they focus on producing items that they can produce more efficiently or at a relatively lower unit cost compared to other countries.
Foreign Exchange Earnings: By exporting, a country earns foreign exchange, which can be used to pay for imports, service external debt, and fund development projects.
Economies of Scale: Export-led growth can lead to economies of scale, where increased production and exports allow firms to achieve lower average costs and higher efficiency.
Technology Transfer and Innovation: Engaging with international markets can expose domestic firms to new technologies and innovation, fostering growth and competitiveness.
Job Creation: As export-oriented industries expand, they create job opportunities in manufacturing, services, and related sectors. There are positive export multiplier effects.

Question 92

Examples of export led growth

Answer 92

China: Since the late 20th century, China has become the “world’s factory,” exporting a wide range of goods, including electronics, textiles, and manufactured goods.
South Korea: South Korea adopted an export-led growth strategy in the mid-20th century, focusing on electronics, automobiles, and steel. This strategy played a significant role in the country’s transformation from low-income to high-income one.
Taiwan: Taiwan’s export-led growth focused on electronics, textiles, and manufacturing. This approach helped the country achieve rapid economic development.
Vietnam: In recent years, Vietnam has experienced rapid economic growth driven by export-oriented industries like textiles, electronics, and agriculture.

Question 93

Risks from dependency on export led growth

Answer 93

Vulnerability to External Shocks: When a country’s economy is heavily dependent on exports, it becomes susceptible to changes in global demand and economic conditions.
Dependence on (volatile) Commodity Prices: Exporting commodities like oil, minerals, or agricultural products exposes a country to fluctuations in global commodity prices, which can lead to government revenue volatility and big changes in the net trade balance
Currency Appreciation: Rapid export growth can lead to currency appreciation, making a country’s exports less competitive and imports cheaper
Lack of Diversification: Overreliance on a few key industries or markets can leave a country vulnerable to changes in those sectors or markets.
Environmental Concerns: Export-oriented industries might prioritize production over environmental sustainability, leading to resource depletion and environmental degradation.

Question 94

Main Benefits of sustained economic growth

Answer 94

-Increased Standard of Living: Economic growth often leads to higher per capita incomes, which in turn can improve the standard of living for a nation’s citizens
-Job Creation: Economic growth can help reduce unemployment rates and provide individuals with greater financial stability.
-Reduced Poverty: Economic growth increases access to education, healthcare, and necessities. Many fast-growing countries have made important progress in reducing extreme poverty and improvements in human development outcomes. (HDI Index)
-Increased Government Revenue: A growing economy generates higher tax revenues that can then be used to fund better public services such as education & healthcare.
-Investment Opportunities: Growth attracts domestic and foreign investment leading to innovation, increased productive capacity (LRAS), and further job creation

Question 95

Main costs of sustained economic growth

Answer 95

-Inflation: Rapid growth can lead to demand-pull and cost-push inflation. If aggregate supply cannot keep up with demand, prices may rise, eroding real purchasing power and potentially leading to economic instability.
-Resource Depletion: Fast growth of GDP can lead to overexploitation of scarce natural resources, such as water, minerals, and energy sources. This can have long-term environmental consequences and compromise sustainability.
-Income Inequality: Rapid growth doesn’t always guarantee equitable distribution of wealth. Benefits of growth may disproportionately accrue to certain segments of the population, leading to increased inequality as measured by the Gini Coefficient.
-Financial Instability: if rapid growth is fueled by excessive borrowing and speculative investment, this can result in financial bubbles and subsequent crashes.

Question 96

positive impact on current living standards

Answer 96

Increased Income and Employment: Rapid economic growth often leads to higher levels of employment and increased wages and income for individuals.
Improved Infrastructure and Services: Economic growth can provide governments with more resources to invest in infrastructure such as roads, bridges, public transportation, and utilities.
Technological Advancements: Rapid economic growth often promotes research and development that can improve the quality of life through innovations in healthcare, communication, transportation, and more.
Reduced Poverty: Growth can lift many families out of poverty by creating opportunities for income generation and improving access to necessities.

Question 97

Why growth can threaten living standards

Answer 97

Environmental Concerns: Rapid economic growth can lead to increased resource consumption and pollution if not managed carefully. Balancing economic growth with environmental sustainability is crucial for ensuring that future generations have access to clean air, water, and natural resources.
Income Inequality: If not properly managed, rapid economic growth can exacerbate income inequality. It’s important to have policies in place that ensure that the benefits of growth are fairly distributed across all segments of society.
Inflation: Rapid growth can lead to higher inflation and threatens real living standards. The impact of high inflation often falls more heavily on families on below-average income leading to an increase in relative poverty.

Question 98

Environmental limits to economic growth

Answer 98

Resource Depletion: Growth often requires increased consumption of natural resources such as minerals, fossil fuels, and forests. These resources are finite, and as they are extracted and used, their availability diminishes.
Climate Change: The adverse effects of climate change, including extreme weather events, rising sea levels, and disruptions to ecosystems, can limit growth potential and often hit poorer countries that are less able to cope with the impact of climate-change related disasters.
Biodiversity Loss: Economic activities can lead to habitat destruction, pollution, and other factors that contribute to the loss of biodiversity. Biodiversity is essential for ecosystem stability, resilience, and the provision of ecosystem services that support human well-being.
Water Scarcity: As demand for water increases due to population growth and economic activities, many regions are facing water scarcity. Industries, agriculture, and households all compete for limited water resources, which can constrain economic growth and lead to conflicts.

Question 99

Main characteristics of a recession

Answer 99

Falling real GDP- one of the primary indicators of a recession is a sustained decline in a country’s GDP over at least 2 consecutive quarters ( 6 months). During a recession, economic output shrinks as businesses produce less, consumers spend less and investment declines.
Rising unemployment- During a recession, there is usually a notable increase in the unemployment rate as businesses reduce production and cut back on hiring, leading to job losses and a rise in cyclical unemployment
Disinflation- In a recession, falling demand and a weaker labour market often lead- perhaps with a time lag- to a reduction in the rate of price inflation.
Reduced business investment- Businesses tend to scale back their investment during a recession because of weak or falling demand.

Question 100

Great Depression in the US

Answer 100

-Duration of depression- 43 months
-Fall in real GDP from peak to trough- 26.5%
-Industrial production fell by 45%
- Increase in unemployment- 24.6%
-Stock prices fell by over 80%

Question 101

Economic and social effects of a recession

Answer 101

-Fall in confidence- a drop in animal spirits
-Rising cyclical unemployment
-Lower rate of inflation- with risk of deflation
-Rising fiscal deficit for the government

Question 102

Economic recovery

Answer 102

An economic recovery is the phase of the business cycle that follows a recession. It may take several years for national output to recover to where it was before a recession
There is no single cause of recovery . Monetary and fiscal policy decisions are important so too economic event in other countries
Recovery can come from:
-Cuts in interest rates (monetary policy)
-One or more types of fiscal stimulus
-A rebound in business and consumer confidence

Question 103

Demand and supply side economic shocks

Answer 103

-Demand side and supply side shocks are two different types of economic disturbances that can impact an economy’s equilibrium. These shocks can lead to changes in various economic indicators such as prices, output and employment
An example of a demand side shock is a financial crisis which reduces consumer and businesses confidence can lead to a sharp decline in spending, causing a demand side shock
An example of supply side shocks is a sudden unexpected rise in commodity prices. Rapid increase in the price of essential commodities can affect production costs and AS

Question 104

Demand and supply side economic shocks examples

Answer 104

-Global financial crisis 2007-9
-Pandemics such as COVID
-Volatile world commodity prices
-Chinese economic slowdown
-Creeping protectionism/ import controls
-Currency volatility and policy changes such as devaluation
-Extreme weather e.g. droughts
-Geo- Political uncertainty and terrorism

Question 105

Moving up the Kuznets curve

Answer 105

-Rapid Industrialisation- heavy industries are often energy intensive
- Increased emissions from urbanisation
-Relatively weak environmental laws and pollution regulations
-Many low income countries have limited technology/ infrastructure
-heavy reliance on dirtier fuels such as coal

Question 106

Moving down the Kuznets curve

Answer 106

Innovation leads to scaled application of cleaner production techniques
Tougher environmental laws- emission zones, clean air acts/ greater awareness
Government policy interventions such as carbon taxes and carbon trading
Change in structure of GDP away from heavy industry towards services
Emergence of policies / capabilities to promote smart urbanisation

Question 107

Sustainable growth

Answer 107

Sustainable economic growth seeks to achieve long term prosperity while also considering the well being of current and future generations as well as the health of the environment
Unlike traditional economic growth, which can often be associated with resource depletion, environmental degradation and social inequalities, sustainable economic growth aims to balance economic progress with social equity and environmental stewardship.
Environmental stewardship promotes resource efficiency, pollution reduction and the conservation of ecosystems

Question 108

Threats to sustainable growth

Answer 108

-Waste from production and consumption
-Pollution and increasing climate change risks
-Depletion of national capital
-Loss of biodiversity

Question 109

Raworths Doughnut model

Answer 109

Inner circle- Social foundation- our basic needs
Outer circle- ecological ceiling
If we stay between these two limitations we are in the safe and just space for humanity

Question 110

Economic Scarring (hysteresis)

Answer 110

Economic scarring refers to the medium-long term damage done to the economies of one or more countries following a severe economic shock which then leads to a recession.
Scarring can happen for a number of reasons:
* Fall in investment leading to an ageing of the existing capital stock
* Rise in long-term unemployment and economic inactivity
* Increase in business failures
*Shrinkage in the capacity of financial system to lend

Question 111

Stages of an economic cycle

Answer 111

Boom- A period when the percentage rate of growth of real GDP is fast and higher than the long-term trend
Slowdown- A weakening of the rate of growth, real GDP is still rising but increasing at a slower rate
Recession- A period of at least six months when an economy suffers a fall in aggregate output, employment, investment and business / consumer confidence
Recovery- A phase after a recession, during which reai GDP scars to increase and unemployment begins to fall
Depression - A prolonged downturn in the economy and where a nation’s real GDP falls by at least 10 per cent

Question 112

Depression vs Recession

Answer 112

A depression is a persistent and severe downturn in output and jobs where an economy operates well below its productive potential and where there can be powerful deflationary forces at work.
Harvard University economist Robert Barro defines it as a decline in per-person economic output or consumption of more than 10%.
Many economic historlans say the line between recession and depression is crossed when unemployment rises above 10% of the labour force and stays there for several years

Question 113

Demand side shocks

Answer 113

Economic downturn in a major trading partner
Unexpected tax increases or cuts to welfare benefits
Financial crisis causing bank lending
/credit to fall
Bigger than expected rise in
unemployment rates

Question 114

Supply side shocks

Answer 114

Steep rise in oil and gas prices or other commodities
Lock-down due to the coronavirus pandemic
Natural disasters causing sharp fall in
production
Unexpected breakthroughs in production technology

Question 115

Key principles of the circular economy

Answer 115

Design for Longevity: Products are designed to have longer lifespans, using durable materials and considering repairability and upgradability.
Closed-Loop Systems: In closed-loop systems, products and materials are recycled, remanufactured, or repurposed rather than disposed of.
Renewable Energy: Clean energy reduces environmental impacts and contributes to a more sustainable system.
Sharing and Collaborative Consumption: Sharing platforms and collaborative consumption models reduces demand for new products and minimizes waste.
Regeneration of Natural Systems: Aim is to regenerate ecosystems and support biodiversity through sustainable land use and resource management.

Question 116

Policies to promote sustainable growth

Answer 116

Carbon taxes (a tax per tonne of carbon)
Carbon trading schemes (permits / credits for pollution)
Tougher environmental regulations such as plastic bans
Spending to protect bio-diversity (marine reserves)
Subsidies for scaling up clean energy generation
Investment in sustainable technologies such as off grid solar
Tax relief on research and development initiatives

Question 117

Stages of the environmental kuznets curve

Answer 117

Low-Income Stage: In the early stages of economic development, countries tend to focus on growth and industrialization. This often involves increased pollution, and degradation of natural ecosystems - environmental quality deteriorates.
Middle-Income Stage: As economic growth continues, the negative impacts on the environment tend to peak. At this point, environmental degradation may be at its worst due to increased industrial activity, urbanization, and consumption.
High-Income Stage: Beyond a certain level of income, the theory suggests that societies become more concerned about environmentar issues. They start investing in cleaner technologies, adopting stricter environmental regulations, and promoting sustainable practices. Environmental quality begins to improve despite ongoing economic growth.

The Environmental Kuznets Curve (EKC) suggests a non-linear relationship between environmental degradation and economic development. It’s named after the economist Simon Kuznets.
The Environmental Kuznets Curve posits that as a country’s economy grows, environmental degradation initially worsens, but after reaching a certain level of economic development, environmental quality starts to improve.
In other words, the relationship between environmental degradation and income follows an inverted U-shaped curve.

Question 118

GNI

Answer 118

Gross National Income is an alternative to GDP as a measure of wealth. It calculates income instead of output.
GNI = GDP + Net Primary Income + Net Secondary Income

Question 119

Net Primary Income

Answer 119

This includes wages, salaries and other income earned by a country’s residents working aboard, as well as earnings from foreign investments, such as dividends and interest

Question 120

Net Secondary Income

Answer 120

This refers to transfers of money between countries such as remittances from foreign workers to their families in their home countries or international aid.

Question 121

Countries with GNI higher than their GDP

Answer 121

-Countries with High Remittances e.g. Mexico, Guatemala
-Countries with Foreign Aid e.g. Gambia, South Sudan
-Countries with Expatriate communities

Question 122

Countries with highest real GNI per capita

Answer 122

-Liechtenstein
-Singapore
-Qatar

Question 123

Measuring standard of living

Answer 123

-Improving human capital
-Getting more people into properly-paid work
-A living wage can help to lift labour productivity
-Accessible and high quality public services
-Better/ affordable housing to rent and buy
-Wealth generated from successful businesses

Question 124

National Income and living standards

Answer 124

What economic information is used to measure the level of and changes in average living standards within an economy?
-Baseline indicator is real national income per capita (GDP or GNI)
-This is real GDP divided by the population = Income per head
-Real means that the income data has been adjusted for the effects of price inflation
-PPP – a purchasing power parity adjustment is made when comparing and contrasting standards of living across countries.

Question 125

Moving beyond income per head

Answer 125

Income per head is a guide to living standards but many economists argue that we should move beyond it as a simple indicator:
-Look at disposable income rather than gross income (not least because the burden of taxes varies between nations)
-Focusing on income per head can ignore deep-rooted inequality
-Median disposable income might be a better measure of living standards for people in the middle of the income distribution
-Income per capita is not always a reliable guide to well-being

Question 126

Disposable income

Answer 126

Disposable income is the amount of money households have available for spending and saving after direct taxes such as income tax and national insurance contributions have been accounted for.
It includes earnings from employment, private pensions and investments as well as cash benefits provided by the state.
There is mean and median disposable income.
Mean household disposable income in the UK was £39,328 in 2019
Median household disposable income in the UK was £32,349 in 2022.

Question 127

Limitations of data on income per head

Answer 127

Changes in the distribution of income (known as relative poverty)
Official data on incomes can be inaccurate – existence of shadow economy where income is earned but not registered for taxation
Regional and local variations in per capita income + rural/urban gaps
Changes in length of working hours and job conditions & security
Problems in accurately measuring a nation’s GDP and price inflation – makes it harder to assess real incomes

Question 128

Why is GDP a flawed guide to living standards

Answer 128

-Ignores the distribution of income and wealth
-Need to consider changing working hours / work-life balance
-Does not include the value of non-marketed output and unpaid work such as family care and voluntary activities
-Rising real GDP may not be sustainable – risk of lost natural capital
-Defensive spending such as cleaning up the effect of pollution & waste and crime prevention add to GDP but hurt welfare
-May not capture value of free services including digital economy

Question 129

Economic well being

Answer 129

Economic well-being refers to the overall quality of life and material prosperity enjoyed by individuals and households.
It encompasses various aspects, including income, consumption, access to basic needs and services, wealth accumulation, job security, social safety nets, and overall life satisfaction.
Measuring economic well-being is crucial for understanding how individuals are faring within the broader economic context and for evaluating the effectiveness of economic policies.

Question 130

Economic growth vs welfare

Answer 130

Economic growth- The sustained growth of real GDP over time
Contributes to rising average living standards (GNI per capita)
Long run increase in a country’s productive capacity

Economic welfare - A broader measure of well-being (social and economic)
Many aspects of well-being are not material aspects of our daily lives
Wellbeing measure might include the level of inequality + median incomes

Question 131

How might well being be measured

Answer 131

-Median Household Income and Real Income Growth:
-Income Inequality: Gini coefficient or other measures of income distribution-
-Wealth and Assets: Including financial assets, property, and investments
-Percentage living below a defined poverty line, often based on income thresholds.
-Underemployment and job security
-Healthy Life Expectancy
-Education: Literacy rates, school enrollment, and attainment levels.
-Surveys that ask individuals about their overall happiness and satisfaction with their lives.
-Inter-Generational Mobility: The extent to which children’s economic outcomes (such as income or education) are related to those of their parents.
-Air and Water Quality: Measures of pollution and cleanliness that impact well-being.

Question 132

Subjective Happiness

Answer 132

Subjective happiness refers to self-reported levels of happiness with one’s life, usually determined using questionnaires.
Measuring subjective happiness usually involves considering emotions, rather than asking about material well- being
Factors that tend to affect your happiness include: your personality and genetics, social influences (including a network of close friends), income and wealth (to a smaller degree than you might expect), health, and ability to enjoy leisure time.

Question 133

Easterlin Paradox

Answer 133

The Easterlin Paradox concerns whether we are happier and more contented as our real living standards improve
Within a society, richer people tend to be happier than poor people.
Richard Easterlin argued that life satisfaction does rise with average incomes but only up to a point.
Beyond that the marginal gain in happiness declines (there are diminishing returns)
One of his conclusions was that someone’s relative income can weigh heavily on people’s minds.
Several papers have contested the findings of the Easterlin Paradox

Question 134

Happy Planet Index

Answer 134

The Happy Planet Index measures life expectancy, experienced well-being, inequality of outcomes, and ecological footprint in order to determine the countries that can deliver the longest and happiest, but also most sustainable lives to their residents.
The Index works to measure efficiency by ranking countries relative to how they offer their people long and happy lives, for each unit of environmental output.

Question 135

Multiplier Ratio

Answer 135

the number of times a rise in national income is larger than the rise in the initial injection of AD, which led to the rise in national income.