Economics Flashcards
Define normative statement.
Subjective statements that contain value judgement, and can not be tested by empirical means.
Eg. The government should increase minimum wage to improve the standard of living.
Define value judgement.
This type of judgement cannot be tested. This judgement is based off that person’s opinion or values.
Define positive statement.
Objective statements that can be tested by emprical means.Eg. The current unemployment rate is 5%
Explain what is meant by the ‘basic economic problem’.
The basic economic problem states that there are infinite wants in society, but only a small and finite amount of scarce resources are available to satisfy those wants.
Define ceteris paribus.
Assuming all other variables are equal. This helps economic assumptions as unlike hypothesis tests in natural sciences, it isn’t possible to keep an invariant control variable.
State the four factors of production.
• Land: Natural resources used in the production of goods and services• Labour: Effort exerted by individuals in the production process, including the skills, abilities, and time they contribute• Capital: Goods that have the potential to generate additional goods or contribute to the production process, eg. machinery• Enterprise: Risk-taking abilities of individuals who manage business ventures and drive economic productivity.
What is the difference between the long-run and the short-run in economics?
The short run refers to a period of time during which at least one factor of production is fixed, while the long run represents a timeframe in which all of the factors of production can be adjusted or varied.
What are the three major assumptions made in all (free-market) economic models?
- Rational Decision-Making by Consumers: Assumes that consumers make choices that maximise their utility or satisfaction.2. Rational Decision-Making by Producers: Assumes that producers aim to maximise their profits.3. Rational Decision-Making by Government: Assumes that the govenment seeks to maximise social welfare.
What are the drawbacks to the three major assumptions made about consumers, producers and the government?
They include unrealistic assumptions, information limitations, behavioral biases, external factors, and the dynamic nature of real-world conditions - such as • Behavioural biases in consumer behaviour• Non-profit and charitable organisations.• Corrupted governments and politicians.
Explain the difference in economic ideologies between Adam Smith, Karl Marx and Friedrich Hayek regarding the efficient allocation of scarce resources.
Adam Smith advocated for free markets and the invisible hand, Marx supported central planning and collective ownership, while Hayek emphasized decentralized decision-making and market competition as means to efficiently allocate scarce resources.
What economic concepts does the Production Possibilities Frontier display?
• Opportunity cost: Favouring the production of one good has an opportunity cost of not being able to produce as much of another good• Scarcity: Downward slope of the PPF, indicating limited resources compared to the potential production of goods or services, necessitating trade-offs in resource allocation.• Allocative efficiency
Why is it not possible to produce beyond the PPF curve?
The PPF represents the maximum potential output given the available resources, technology, and production efficiency, indicating the limits a firm, or economy’s maximum productive capacity
How is it possible to shift a PPF curve outwards?
Advancements in technology, increase in availability of resources, increased investment into capital goods.
Define opportunity cost.
Opportunity cost refers to the value of the next best alternative forgone when a choice is made.
Why may consumers not behave rationally?
Consumers may not behave rationally due to factors like limited information, cognitive biases, emotional influences, time constraints, social pressures, and individual preferences
What is a command economy, provide one advantage and disadvantage.
A command economy is an economic system in which the government owns all of the factors of production.• Advantage: Maximum welfare, low unemployment and minimal income inequality• Disadvantage: Lack of innovation, risk-taking and efficiency (no incentive for profits)
What is a free-market economy, provide one advantage and disadvantage.
A free-market economic is an economic system in which there is no government intervention in the production of goods and services, allowing only the forces of supply and demand to allocate resources.• Advantage: Greater allocative efficiency since firmshave the incentive to produce goods in the most efficient way• Disadvantage: Monopolies may emerge as a result of no government intervention
What is meant by specialisation and division of labour?
Specialization refers to the focus of individuals, firms, or regions on specific tasks while division of labor involves breaking down the production process into separate tasks performed by different individuals to increase efficiency and productivity.
Who founded the idea of the specialisation and division of labour?
Adam Smith founded the ideology of specialisation and division of labour.
Provide two advantages and two disadvantages to the specialisation and division of labour.
• Advantage: Lower unit costs as workers become more skilled at their jobs –> Internal economies of scale• Advantage: Increased efficiency and greater productivity• Disadvantage: Boredem due to repetitiveness can cause a decline in productivity• Disadvantage: Dependency on others areas of production - if one part of process is disrupted, this can lead to a fail in the supply chain.
What are the four functions of money?
• Medium of Exchange: Money serves as a widely accepted means of payment, facilitating transactions by acting as a medium for exchanging goods and services.• Measure of Value: Money provides a standardized measure of the worth or value of goods, services, and assets, allowing for comparisons and pricing.• Store of Value: Money allows individuals to store and preserve wealth over time, maintaining its value for future use and preventing loss of purchasing power.• Standard of Deferred Payment: Money serves as a reference point for settling debts and fulfilling financial obligations at a later time, establishing a standard for credit transactions and contractual agreements.
Define market demand.
The quantity of a good or service that consumers are willing and able to purchase at a given price level.
Explain what is meant by the law of diminishing marginal utility.
The law of diminishing marginal utility states that as the consumption of a good or service increases, the additional satisfaction or benefit derived from each additional unit gradually decreases.
Explain what is meant by a derived demand, with an example?
Derived demand refers to the demand for a good or service that arises from the demand for another good or service, typically linked in the production process or as complementary goods.Eg. Steel demand in the construction industry is derived from the demand for new buildings and infrastructure projects
Explain what is meant by a composite demand, with an example?
Composite demand refers to a situation where a good or resource is demanded for multiple uses or purposes, making it challenging to allocate resources effectively between different uses. Eg. Sugar is demanded by both the food industry, and the beverage industry.
What are the shifters of demand?
• Population: Higher population, moredemand• Incomes: Higher incomes, more demand• Related goods: Price of compliments and substitutes• Advertisements: Increase in brand loyalty, more demand• Tastes: If preferences shift toward product, more demand• Expectation: Speculation on future price changes• Season: Dependent on time of year
Why is there an inverse association between price and quantity demanded?
The law of demand states that higher prices discourage consumption, leading to a lower quantity demanded, while lower prices incentivize consumption, resulting in a higher quantity demanded.
Outline three factors that affect the price elasticity of demand.
• Availability of susbsititutes: Lots of substitutes = Elastic demand• Percentage of income spent on good: Large proportion = Elastic, Small proportion = Inelastic• Necessity: Addictive = Highly inelastic
Define price elasticity of demand.
Price elasticity of supply is defined as the responsivess of quantity demanded following a change in price.PED = (Δ%Qd)/(Δ%P)
What is the impact on total revenue if the price of a good who’s PED is inelastic is increased?
Total revenue will increase, as the decrease in quantity demanded is proportionately smaller than the increase in price.
What is the impact on total revenue if the price of a good who’s PED is elastic is increased?
Total revenue will decrease, as the decrease in quantity demanded is proportionately larger than the increase in price.
Provide an example of a good with a relatively elastic demand, and a good with a relatively inelastic demand.
• Elastic: Clothing• Inelastic: Petrol
Define market supply.
The quantity of a good or service that suppliers are willing and able to produce at a given price level.
What are the shifters of supply
• Productivity: Higher productivity, more supply• Indirect taxes: More taxes = Lower costs of production, more supply• Number of firms in industry: More firms, more supply• Technological advancements: Better technology, more supply• Subsidies: More subsidies, more supply• Weather: (only applicable for agriculture and housing industry). Better weather = more supply• Costs of production: Lower costs of production = more supply
Explain what is meant by a joint supply?
Joint supply refers to a situation in which the production of one good results in the simultaneous production or availability of another good as a byproduct
Why is there a positive association between price and quantity supplied?
The law of supply states that higher prices encourage production, leading to a higher quantity supplied, while lower prices disincentivize production, resulting in a lower quantity supplied.
Define price elasticity of supply.
Price elasticity of supply is defined as the responsivess of quantity supplied following a change in price.PED = (Δ%Qs)/(Δ%P)
Outline three factors that affect the price elasticity of supply.
• Availability of resources: Greater availability, more elastic• Production time lag: Low time lag, more elastic• Mobility of factors of production: More mobile factors, more elastic
Why is supply price inelastic in the short run?
Supply price is inelastic in the short run due to limited production capacity and constraints in adjusting inputs promptly.
Provide an example of a good with a relatively elastic supply, and a good with a relatively inelastic supply.
• Elastic: Sports car• Inelastic: Housing in UK
Define income elasticity of demand.
The responsiveness of demand to a change in income.YED = (Δ%Qd)/(Δ%Y)
What is a normal good, and why is their income elasticity of demand positive?
A normal good is a good whose demand increases as incomes rise. This means their YED = +/+ = Positive.
Provide an example of a normal good.
Clothing.
What is a luxury good?
A good which is not essential for survival, such as a sports car, and its YED > 1.
Provide an example of an inferior good.
Off-brand food products.
What is an inferior good, and why is their income elasticity of demand negative?
An inferior good is a good whose demand falls as incomes rise. This means their YED = -/+ = Negative.
Define cross elasticity of demand.
The responsiveness in the quantity demanded of good A following a change in price of good BXED = (Δ%Qd(A))/(Δ%P(B))
Two goods have a positive cross elasticity of demand, this means that they are…
Substitutes - a rise in price of good A leads to an increase in demand for good B)
Two goods have a negative cross elasticity of demand, this means that they are…
Complements - a rise in price of good A leads to a decrease in demand for good B)
Explain Adam Smith’s theory of the invisible hand.
Describes the unseen forces of self-interest that impact the free market for the most optimal level of resource allocation.
Explain the functions of the free-market price mechanism.
- Signals to producers that prices are too high/low22. Incentivises producers to increase/decrease prices3. Rations excess supply and demand4. Allocation of scarce resources
Explain how the price mechanism reduces excess demand.
- Excess queueing, waiting lists and competition between buyers to purchase good (Signal is sent to producers that prices are too low)2. Higher price and make more revenue and profit (Incentive sent to producers)3. Extension in supply, contraction in demand - market has re-established equilibrium (Excess demand is rationed away)4. Resources reallocated at the free-market equilibrium, where there is no excess supply or demand.
Explain how the price mechanism reduces excess supply.
- Excess unsold stocks on shelves (Signal is sent to producers that prices are too high)2. Lower price and make more revenue and profit (Incentive sent to producers)3. Contraction in supply, extension in demand - market has re-established equilibrium (Excess supply is rationed between consumers)4. Resources reallocated at the free-market equilibrium, where there is no excess supply or demand.
Define consumer surplus.
The difference between the price that consumers are willing and able to pay, and the price they actually pay.
Define producer surplus.
The difference between the price at which producers are willing and able to sell a good or service and the price they actually receive.
Explain the difference between partial and complete market failure.
Partial market failure occurs when the forces of supply and demand fail to efficicently allocate resources, while complete market failure refers to the total absence of goods or services provision by markets.
Define externality.
An externality occurs when the production or consumption of a good or service has unintended consequences on a third party for which no compensation or payment is made in the market
Define external costs and benefits. (MEC / MEB)
External costs (MEC) are negative consequences or expenses imposed on society due to an economic activity, with the responsible party not bearing the full cost. External benefits (MEB) are positive effects or advantages experienced by others or society from an economic activity, with the responsible party not providing the full benefit.
Define private costs and benefits (MPC / MPB)
Private costs (MPC) are the expenses that a person or firm pays in order to buy, or produce goods and servicesPrivate benefits (MPB) are the benefit derived by an individual or firm directly involved in a transaction as either buyer or seller
Define social costs and benefits (MSC / MSB)
Social costs (MSC) refer to the total expenses or negative consequences borne by society as a whole due to an economic activity, including both private costs and external costs. MSC = MPC + MEC.Social benefits (MSB) are the overall advantages or positive outcomes received by society as a whole from an economic activity. MSB = MPB + MEB.
What does it mean to internalise an externality?
To ensure that the costs or benefits associated with an economic activity are accounted for by the parties involved in the transaction, rather than being externalized towards society.
Define merit good with an example.
Merit goods are goods or services that provide positive externalities of consumption (external benefits to society, leading to social welfare gain), and are often underprovided by the free-market, such as the National Health Service (NHS) in the UK, which provides essential healthcare services to the population.
Define demerit good with an example.
Demerit goods are goods or services that provide negative externalities of consumption (external costs to society, leading to social welfare loss), and are typically overprovided by the market, such as alcohol, which can lead to health issues, addiction, and social problems.
Why is the social-optimal level of output not equal to the free-market equilibrium for all merit and demerit goods and services?
The free-market does not consider the full social costs or benefits of merit and demerit goods. Positive externalities of merit goods are underproduced due to undervaluation, while negative externalities of demerit goods result in overproduction. Government intervention is necessary to align market outcomes with the socially optimal level of output.
What is the triangle of deadweight loss / net social welfare loss?
The triangle of net social welfare loss represents the inefficiency and loss of overall societal welfare when the quantity of a good or service produced and consumed deviates from the socially optimal level due to externalities.
Which direction does the triangle of net social welfare loss point towards.
The social optimum level of output, where MSC = MSB.
Define public good with an example.
A public good is a good or service that is non-excludable and non-rivalrous, meaning that its use by one individual does not diminish its availability to others. An example of a public good is street lighting, as it benefits the entire community and cannot be easily restricted or used up by one person’s consumption.
Define quasi-public good.
A good or service that possesses characteristics of both public and private goods, exhibiting partial rivalry or partial excludability.
What is meant by the ‘free rider problem’?
Where individuals benefit from a public good without contributing to its production or funding, taking advantage of the fact that the consumption of the good cannot be restricted.
Define information failure.
Where one, or both parties of a transaction possesses incomplete, inaccurate, or asymmetric information, leading to suboptimal decision-making and market inefficiencies.
What is meant by asymmetric information.
Where one party in an economic transaction has more information or knowledge than the other party, creating an imbalance in the information available.
Define government intervention.
Government intervention refers to the actions taken by the government to regulate economic activities in order to correct market failures
Define indirect tax.
A tax levied on spending rather than directly on income, profit or commission, typically imposed at the point of production, sale, or consumption
What is the difference between ad valorem and excise duty, give 3 examples of each.
An Ad valorem tax is a tax levied as a percentage of the price of the good or service, while excise duty is a set amount of tax imposed on goods and services.
Why do ad valorem supply curves diverge from the original supply curve?
Tax imposed as a percentage of the product’s price increases the cost of production for suppliers, leading to a higher price required for suppliers to be willing to produce the same quantity, resulting in a diverging shift of the supply curve.
What are the advantages to indirect tax intervention?
• Generates fiscal dividends for the government which can be reinvested into public infrastructure and development• Market failure corrected as the external cost of negative externalities is internalised• Behaviour changes can be made if indirect taxes are imposed, discourage consumption of demerit goods.
What are the disadvantages to indirect tax intervention?
• Regressive impact on those on lower incomes• May encourage black-market activity• Can cause cost-push inflation
Why are indirect taxes considered to be regressive?
They tend to impose a proportionately higher burden on lower-income individuals or households compared to higher-income individuals, as the tax burden represents a larger share of their income.
How do you determine the distribution of tax burden between consumers and producers on a supply and demand analysis?
Top rectangle represents incidence of indirext taxation on consumers. If demand is inelastic, burden of tax will fall mainly on consumers.Bottom rectangle represents incidence of indirext taxation on producers. If demand is elastic, burden of tax will fall mainly on producers.
Evaluative statements for effectiveness of indirect tax intervention.
• Magnitude of the tax (hard to determine)• Price elasticity of demand/supply• Workers may lose their jobs, firms may shut down or migrate to a different nation• Consumers may switch to untaxed substitutes• Black markets can reduce the total tax revenue
Define subsidy.
A government grant to firms producing merit goods, which aims to reduce production costs and encourages an increase in output.
What are the advantages to subsidy intervention?
• Market failure corrected, level of production increased to match social optimum.• Can incentivise research and development• Has the potential to create job opportunities
What are the disadvantages to subsidy intervention?
• Can pose as a budgetary burden on the government• Firms may become overly dependent on the subsidy• Can discourage innovation and efficiency
How do you determine the distribution of subsidy benefit between consumers and producers on a supply and demand analysis?
Top rectangle represents benefit of subsidy on producers. If demand is inelastic, benefit of subsidy will fall mainly on consumers.Bottom rectangle represents benefits of subsidy on consumers. If demand is elastic, benefit of subsidy will fall mainly on producers.
Evaluative statements for effectiveness of subsidy intervention.
• Magnitude of the subsidy (hard to determine)• Price elasticity of demand/supply• Opportunity cost - can the money be better used elsewhere• Dependence/reliance on subsidy• Producers may not pass down the benefit of the subsidy
Explain the concept of tradable pollution permits.
Tradable pollution permits are market-based instruments that set a limit on pollution and allow entities to buy, sell, or trade permits, incentivising pollution reduction and the efficient allocation of emissions.
What are the advantages to tradable pollution permits?
• Government gains revenue from selling permits and fining firms who exceed their pollution quotas• Incentivises investment into greener technology (economic sustainability)• Guaranteed that pollution will fall because supply of limits is perfectly inelastic
What are the disadvantages to tradable pollution permits?
• Can be costly to monitor (government failure if costs are greater than benefits)• Difficult to determine how many tradable permits should be sold• Raises costs for firms, causing higher prices for consumers
What are the advantages to maximum and minimum prices?
• Protects markets from externalities • Maximum prices can protect consumers from price exploitation by ensuring that essential goods remain affordable• Minimum prices ensure that producers receive a fair return on their investments• Reduced market price volatility
What are the disadvantages to maximum and minimum prices?
• Distortion to price signals and causes excess supply or excess demand• Difficult to determine where to set prices• Can lead to the creation of black markets
What are the advantages to market regulation?
• Consumer protection from exploitation and fraud• Regulation policy prevents monopolistic competition• Can achieve public interest and social objectives by addressing externalitise and other sources of market failure
What are the disadvantages to market regulation?
- Monitoring firms for the compliance of passed regulation and laws can be costly - fiscal opportunity cost
- Excessive regulation can reduce competition and allocative efficiency in markets by increasing bureaucracy and reducing innovation
- Costs may be passed onto consumers in the form of higher prices
What are the advantages to state provision of public goods?
• Market failures such as non-excludability and non-rivalry corrected as the free-market is not willing to provide public goods• Reduces inequality and improves standards of living• Ensures the stability and security of a nation (ie. nuclear defense system)
What are the disadvantages to state provision of public goods?
• Free-rider problem• Potential inefficiencies may arise as there is a lack of innovation and competition• Risk of monopoly power
What are the advantages to information provision?
• Helps consumers act more rationally, causing market to work in favour society• Improved decision-making in markets• Can incentivise firms to produce, stimulating growth• Public health and safety (ie. effects of smoking)• Empowerment of consumers as there is less information asymmetry between parties
What are the disadvantages to information provision?
• Can be costly to enforce information provision• The government may not possess perfect information themselves• Consumers may behave irrationally, or follow behavioural and cultural biases instead
Define government failure.
When the costs of government intervention outweigh the benefits intended by the action, can lead to a misallocation of scarce resources.
Define government bureaucracy.
Government bureaucracy refers to the administrative officials within a government that are responsible for implementing policies, regulations, and public services.
Define regulatory capture.
Regulatory capture refers to a form of political corruption in which regulatory agencies, tasked with protecting public interest, become influenced or controlled by the industries or entities they are supposed to regulate, leading to biased or ineffective regulation.
Why may government failure occur?
- Imperfect information2. Red tape effect3. Costs of regulating and monitoring4. Costs of administrating5. Regulatory capture6. Time lags from time of intervention to time of effect
Provide 3 examples of government failure by unintended consequences.
- Minimum wage laws intended to improve workers’ welfare may lead to job losses and reduced employment opportunities, particularly for low-skilled workers.2. Price controls imposed to make goods more affordable can result in shortages and black markets as suppliers are disincentivized to produce and distribute the goods at artificially low prices.3. Agricultural subsidies aimed at supporting farmers and ensuring food security may distort market incentives, leading to overproduction, environmental harm, and inefficient allocation of resources.
Explain how GDP (Gross Domestic Product) is calculated.
Sum of the total value of all goods and services produced within an economy during one year. GDP = C + I + G + (X-M)
Discuss GDP’s limitations in evaluating standards of living within an economy
GDP does not consider several key factors such as:• Where the wealth is stored, ie. income inequality• Environmental sustainability• Access to, and the provision of public/merit goods such as healthcare• Economic and price stability• Availability of credit, education opportunities and basic necessities (such as water, food and energy)
Describe what is meant by GNI (Gross National Income)
The total income earned by a country’s residents, including both domestic, and international sources
What may be a better depiction of standards of living within an economy?
GDP per capita, or Gross National Happiness (GNH)
Define Purchasing Power Parity (PPP).
A comparison of the relative purchasing power of different currencies by equalizing the prices of a basket of goods and services across countries
Give an example of when Purchasing Power Parity may be useful.
Used for accurate international comparison of living standards and economic indicators like GDP between countries with different currencies, and price levels.
Discuss the various components within the circular flow of income model.
- Households: Pay firms for goods and services.2. Firms: Pay households for human capital/labour.3. Governments: Collect tax revenue from both households and firms; Pay firms to buy goods and services; Pay welfare benefits to households.4. Financial Sector: Collect savings, Pay withdrawals5. Other Nations: Collect imports, Pay for exports.
Give 3 examples of withdrawals, and injections into an economy.
Withdrawals:• Savings• Imports• TaxationInjections:• Withdrawals• Exports• Government spending
What is depicted on the economic cycle?
Depicts fluctuations in economic activity over time, involving periods of boom (positive output gap) and recession (negative output gap).Trend rate of GDP growth (on the PPF) is the economy’s productive potential.Actual rate of GDP growth is the economy’s current position in terms of economic activity.
What factors have the potential to cause long-run economic growth?
• Technological advancements and innovation.• Investment in physical and human capital.• Improvements in education and skilled workforce.• Access to financial resources and credit• Infrastructure development• Research and development
What are the main benefits of economic growth?
- Lower levels of unemployment
- Higher nominal incomes –> Higher standards of living
- Greater fiscal dividends (tax revenue) for the Government to reinvest back into providing higher quality public services
- Attractive to foreign investors looking to start-up in the UK
- More production in the economy –> More exports, leads to higher competitiveness in the global trade market
What are the main negative consequences of economic growth?
• High likelihood of demand-pull inflation• Environmental degradation and resource depletion• Increased carbon emissions leading to climate change• Mental health and social issues - workers forced to work longer hours than they would like• Economic instability
What factors affect the level of Consumption within an economy?
• Disposable income: Higher levels of income generally lead to increased consumption.• Consumer confidence• Interest rates: Lower interest rates can incentivize borrowing and increase consumption.• Availability of credit: Easy access to credit can facilitate higher levels of consumption.• Wealth and asset prices: Rising asset prices, such as housing or stock market values, can boost consumer spending.
What factors affect the level of consumer confidence within an economy?
• Unemployment rates and level of price stability• Value of consumer assets and house prices• Standards of living• Average incomes• Consumer expectations (anticipations of future economic growth and/or job opportunities)
How do you calculate the Marginal Propensity to Consume (MPC)?
MPC is calculated as the change in consumption divided by the change in disposable income.
Discuss what is meant by a multiplier effect.
When an initial injection of money into the economy leads to a proportionately larger final increase in AD.
Discuss what is meant by a ‘positive wealth effect’?
A psychological phenomenon stating that when asset values rise, this makes individuals feel wealthier, leading to increased spending and a boost in overall consumption and economic activity
What factors affect the level of Investment within an economy?
• Availability of credit and financing• Business confidence• Level of economic growth• Interest rates• Value of privately owned assets• Foreign demand for exports• Technological advancements
What factors affect the level of business confidence within an economy?
• Availability of credit and financing• Unemployment rates and level of price stability• Level of economic growth• Interest rates• Competition within markets and market demand• Availability of commodities/resources
Discuss what is meant by an accelerator effect.
When changes in investment spending have a magnified impact on the level of economic output
Define animal spirits.
Keynesian ideology stating that psychological factors driving economic behavior and decision-making. Factors such as confidence, optimism, risk-taking, and herd mentality can influence individuals and businesses in their economic choices.
How do you calculate the Marginal Propensity to Withdraw (MPW)?
MPS + MPT + MPM
How do you calculate the spending multiplier co-efficient in an economy?
1 / 1-MPC = 1/MPW
What is a credit crunch?
A credit crunch is a sudden reduction in credit availability, leading to restricted borrowing and higher borrowing costs.
Describe the factors that can cause a credit crunch.
• A financial crisis• Banking system instability• Excessive lending and borrowing• A decline in asset values• Loss of confidence in the economy
Define economically active.
Individuals who are either employed or actively seeking employment, indicating their participation in the labor market and their willingness and ability to work
Define unemployment
Proportion of economically active individuals within an economy who are willing and able to work but can not find a job.
Define cyclical unemployment
Unemployment resulting from fluctuations in the business cycle and economic downturns.
Define frictional unemployment
Unemployment resulting from the time taken for individuals to switch jobs or find new employment.
Define structural unemployment
Unemployment arising from reduced or eliminated jobs and skills mismatch in the labor market.
Define seasonal unemployment
Unemployment that occurs due to predictable, temporary fluctuations in demand for labor during certain seasons or specific times of the year, such as agricultural or tourism-related industries.
Define real-wage unemployment
Unemployment caused by wages being set above the equilibrium level, resulting in a surplus of labor, as employers are unwilling or unable to hire workers at the prevailing wage rate.
Define hysteresis.
Hysteresis occurs when a temporary shock or disturbance to an economy leads to lasting or permanent changes in variables such as employment, output, or productivity, preventing a return to the previous state.
What is the difference between those who are economically active, and those who are employed in a job?
Economically active individuals are those who are either employed or actively seeking employment, employed have a job or are engaged in work, regardless of their level of economic activity.
What are the benefits to using the claimant count to measure the rate of unemployment?
• Claimant count data is often available on a monthly basis, providing more timely information about the state of unemployment compared to other measures.• Relies on existing administrative records, making it a relatively cost-effective and efficient way to estimate unemployment rates• Provides a consistent measure over time, allowing for meaningful comparisons and analysis of trends in unemployment.
What are the drawbacks to using the claimant count to measure the rate of unemployment?
• Excludes individuals who are unemployed but not eligible for, or not claiming benefits• Some individuals may choose not to claim benefits due to the stigma associated with unemployment or personal reasons• Includes individuals who voluntarily leave their jobs, making it difficult to differentiate between voluntary and involuntary unemployment
What are the benefits to using the Labour Force Survey (LFS) to measure the rate of unemployment?
• Captures a wide range of demographic and labor market information, providing a comprehensive view of the workforce beyond just those eligible for unemployment benefits.• Uses rigorous sampling techniques to ensure the data represents diverse groups and regions accurately• Collects detailed data on employment status, occupation, industry, and hours worked• Regularly conducted, the LFS enables tracking of trends over time, providing valuable insights into changes in employment rates, workforce participation, and unemployment dynamics
What are the drawbacks to using the Labour Force Survey (LFS) to measure the rate of unemployment?
• Sample may not fully represent the entire population, leading to potential inaccuracies, especially for smaller subgroups or localized areas• Voluntary responses in the LFS can introduce response bias, because certain individuals may be more or less likely to participate• LFS is conducted less frequently than administrative data sources, limiting the timeliness of the information provided
What is meant by underemployment, and how can this have negative impacts on the economy?
Underemployment refers to workers who are employed in jobs that do not fully utilize their skills, or work desired working hours. This reduces productivity, dampens economic growth, and leads to wasted human capital, resulting in lower income levels, decreased consumer spending, and overall economic inefficiency.
What is the impact of high unemployment rates on individuals?
High unemployment rates can result in financial stress, reduced well-being, career setbacks, social isolation, and negative health consequences for individuals.
What is the impact of high unemployment rates on firms?
High unemployment rates can lead to reduced consumer spending, lower production and output, decreased business investment and increased market competitiveness, so wages decrease.
What is the impact of high unemployment rates on the Government?
High unemployment rates increase government spending on social welfare programs while reducing tax revenue, causing a fiscal deficit to become worsened.
What is the impact of high unemployment rates on the trade balance?
High unemployment has the potential to improve the net trade balance. Low levels of productive output, leading to less net exports, leading to a worsening of the net trade balance.It can also be argued that high unemployment rates can contribute to a decrease in imported goods due to reduced domestic demand, resulting in an improvement in the trade balance.
Define inflation
The sustained rise in general price level over a given time period.
Define Consumer Price Index (CPI).
A newer measure of inflation, monitors the change in the price level within an economy for a basket of goods purchased by households which is used to monitor inflation.
How are index numbers calculated?
(Index / Base Year) * 100The base year is always set at an index value of 100.
State an advantage and disadvantage of using CPI to measure the rate of inflation within an economy.
Advantage of CPI: Comprehensive measure of inflation tracking changes in prices of goods and services.Disadvantage of CPI: May not fully reflect inflation experienced by specific demographic groups with different consumption patterns.
Define Retail Price Index (RPI).
An older measure of inflation, less commonly used than CPI, although works on the same basis of monitoring the value of a basket of goods.
State an advantage and disadvantage of using RPI to measure the rate of inflation within an economy.
Advantage of RPI: Broader inclusion of housing-related costs such as mortage repayments and council tax.Disadvantage of RPI: Tends to yield higher inflation figures, potentially overstating true inflation rate.
What are the main differences between RPI and CPI measures of inflation?
- Calculating method2. Weighting method3. Coverage of housing costs (CPI includes housing costs, whereas RPI tracks mortgage repayments and council tax)
Define Consumer Price Index for Housing (CPIH).
A measure of average price level changes in an economy for goods and services that includes housing costs for homeowners, used to track inflation and cost of living.
State an advantage and disadvantage of using CPIH to measure the rate of inflation within an economy.
Advantage of CPIH: Includes housing costs, providing a more comprehensive measure of inflation that reflects the impact on households.Disadvantage of CPIH: Relies on certain assumptions and imputations for estimating owner-occupier housing costs, which may introduce potential inaccuracies in measurement.
What is meant by the ‘basket of goods’?
A selected set of goods and services that most accurately depict the spending habits of an economy, which are used to calculate price indexes.
How are goods and services weighted in the basket of goods?
Weighted based on their share of total consumer expenditure, which are typically determined using data from surveys or expenditure data. The more frequently and extensively a good or service is purchased, the higher its weight in the basket of goods.
Why are goods and services weighted in the basket of goods?
Goods and services are weighted in the basket to reflect their importance in consumer spending patterns, and provide a more accurate measure of inflation and costs of living.
What is meant by cost-push inflation?
An increase in cost of production or a decrease in the availability of resources leading to an inward shift of supply causing higher prices.
What is meant by demand-pull inflation?
When the level of aggregate demand within an economy rises and beyond the productive potential output (supply remains constant) resulting in higher prices of goods and services.
Define shoe leather costs.
The increased time and effort spent by individuals and businesses in response to inflation, such as more frequent trips to the bank to withdraw cash, in order to minimize the loss of purchasing power.
Define menu costs.
Menu costs are the expenses and inconveniences that businesses face when changing their prices due to inflation.
What is the difference between cost-push and demand-pull inflation?
Cost push inflation is derived from an increase in production costs (ie. from a supply shock), whereas demand-pull inflation is derived from excess demand within an economy forcing producers to drive up prices.
What is a wage-price spiral.
When higher wages lead to higher price levels throughout the economy, resulting in workers demanding for even higher wages, creating an inflationary cycle.
What are the consequences of sustained high rates of inflation?
• Reduced purchasing power: High inflation diminishes the value of money, reducing individuals’ ability to buy goods and services.• Reduced savings and investment: Inflation erodes the value of savings, discouraging saving and reducing funds available for investment.• Increased production costs: Businesses face higher production costs due to rising wages and input prices, potentially squeezing profit margins.• Income redistribution: Inflation affects different income groups unevenly, widening income disparities.• Macroeconomic instability: High inflation decreases economic confidence and can lead to currency depreciation
What is the impact of high inflation rates on firms?
High inflation rates increase production costs, creating uncertainty in planning and pricing decisions, and potentially reducing investment and growth opportunities.
What is deflation, and why is it not a good thing?
Deflation is a sustained decrease in the general price level of goods and services. It can lead to a negative wealth effect and worsened confidence within the economy.Deflation can:• Reduce consumer spending and hinder economic growth• Increased debt burdens, ,• create a cycle of falling prices causing businesses to cut production, investment, and employment, (exacerbating the economic downturn)
What is the impact of high inflation rates on individuals?
High inflation rates reduce individuals’ purchasing power, erode real wages, create financial uncertainty, distort economic decision-making, and can widen income disparities.
What is the impact of high inflation rates on the Government?
High inflation rates impact the government by reducing the purchasing power of government spending, and makes it more costly to borrow money, potentially worsening national debt in the long run.
What is the impact of high inflation rates on the trade balance?
High inflation rates can potentially decrease imports and improve the trade balance as the reduced purchasing power of domestic currency makes imported goods relatively more expensive.
Why is there often a trade off between the rate of inflation and unemployment?
Policies that aim to reduce unemployment can potentially lead to higher demand-pull inflation, and policies targeting inflation reduction may result in increased unemployment.
What does the Phillip’s curve depict?
The Phillips curve depicts the inverse relationship between unemployment and inflation (in the short run). As unemployment decreases, inflation tends to increase, and vice versa, implying a trade-off between the two variables.
What are the limitations to the analysis of the Phillips curve?
Long-run inconsistency due to factors like inflation expectations, changes in economic structure, and supply-side shocks; the presence of unstable policy trade-offs between unemployment and inflation; the influence of structural changes in the economy such as technological advancements
What is meant by stagflation, what can cause stagflation and what are the potential implications?
Stagflation refers to a situation of stagnant economic growth coupled with high inflation, which can be caused by supply-side shocks or a combination of factors such as rising energy prices, declining productivity, or government policies.
What are the 4 sections in the current account balance?
- Trade of goods / visibles (X-M)2. Trade of services / invisibles (X-M)3. Primary income: Wages, profits and commissions earnt from abroad.4. Secondary income: Money transfer payments sent abroad.
Why do high relative inflation rates reduce global economic competitiveness?
High relative inflation rates reduce global economic competitiveness by eroding the price competitiveness of domestic goods and services, leading to a decline in exports, reduced market share, and potential negative impacts on employment, economic growth, and trade balance.
What are the reasons an economy may face a current account surplus?
• A weak relative currency can reduce the price of exports, leading to greater export demand.• Individuals moving ‘hot money’ over in the form of transfer payments (ie. remittance) because of higher differential interest rates.• Lower incomes can lead to lower import demand
What are the implications of a trade surplus?
• Improved current account balance:• Increased foreign currency reserves as money is injected into the economy• Boost to domestic industries and employment• Potential currency appreciation: A trade surplus can lead to an increase in demand for the country’s currency, potentially resulting in currency appreciation
What are the reasons an economy may face a current account deficit?
• Strong relative currency can increase the demand for imports, while decreasing the demand for exports• Hot money flowing into other economies due to higher reward for saving elsewhere can cause a deficit in secondary income flow• Borrowing and interest payments: An excessive amount of external debt to foreign creditors can lead to an outflow of money from the economy• Dependence on imported raw materials and resources causes a constant outlflow of money from the economy
What are the implications of a trade deficit?
• Increased foreign debt as financing may be conducted from foreign creditors• Hindrance of economic growth (lack of domestic competition between firms)• Dependence on foreign production• Potential currency depreciation as demand for domestic currency decreases
What is the effect of a strong pound on the net trade balance?
SPICED. Strong Pound Imports Cheap Exports Dear.Net trade balance worsens as import demand rises and export demand falls.
What is the effect of a weak pound on the net trade balance?
WPIDEC. Weak Pound Imports Dear Exports Cheap.Net trade balance improves as import demand falls and export demand rises.
What does the J-curve depict?
Shows that a depreciation of the currency will cause a short-term deterioration of the net trade balance followed by a subsequent improvement.
What are the limitations to the analysis of the J-curve?
• Assumes that the price elasticity of demand for exports and imports remains constant over time• Does not consider other factors that can influence the trade balance, such as non-price competitiveness, productivity, and changes in domestic and foreign economic conditions• The time frame for the adjustment depicted by the J-curve can vary, and the actual magnitude and duration of the impact may differ in different situations
