1.6 The level of overall economic activity

Question 1

What are the factors of production

Answer 1

1. Interest
2. Wages
3. Rent
4. Profit

Question 2

Injections

Answer 2

Putting money into the economy. (Investment, government spending, export expenditure).

Question 3

Leakages

Answer 3

Taking money out of the economy. (Saving, taxes, imports)

Question 4

GDP

Answer 4

the total value of all final goods and services produced in a country during one year.

Question 5

GNI

Answer 5

It is the GDP produced by nationals + NET income.

Question 6

AD

Answer 6

total demand for goods and services in an economy at a given time (AD= C+ I+ G+ (X-M))

Question 7

Why does AD slope downwards?

Answer 7

When average PL increases, consumers will buy less goods and services. (There is a negative relationship between pice and demand )

Question 8

What causes movements of AD?

Answer 8

Changes in PL

Question 9

What causes AD to shift?

Answer 9

when when of the components that make up AD increase or decrease.

Consumption: consumer confidence, interest rates, wealth, disposable income, income tax, level of household debt

Investment: Interest rates, Business confidence, level of technology, business tax, level of corporation tax.

Government spending: Policy choices of the government.

Net exports: Income of trading partners, Value of home currency, value of foreign currencies, level of protectionism.

Question 10

Unemployment

Answer 10

all people of working age that are not working and are

actively looking for a job.

Question 11

What are the Economical Consequences of unemployment?

Answer 11

• Loss in GDP (drop in production).

• Loss of tax revenue, because
unemployed people have less income to
pay taxes.

• Increased cost of unemployment
benefits. (Which affect the government)

• Loss of income for individuals.

• Greater differences in income
distribution.

Question 12

What are the Personal Consequences of unemployment?

Answer 12

-Increased crime rates, using crime to
increase money to spend.

• Increased stress levels; worries over
money

• Increased indebtedness.

• Being unable to pay for housing;
homelessness.

• Family breakdown.

Question 13

Cyclical unemployment

Answer 13

Occurs during the downturns of the business cycle, when the economy is in a recessionary gap.
- Low AD

(Example: GDP falls, so demand for jobs falls as well)

Question 14

Frictional Unemployment

Answer 14

when between jobs

Question 15

Seasonal unemployment

Answer 15

Not being able to work due to the season

Question 16

Structural unemployment

Answer 16

1. Change in demand for a particular labour skills
2. Movement of firms
3. Labour market rigidities

Question 17

Inflation

Answer 17

a sustained increase in the level of prices

Question 18

Disinflation

Answer 18

a persistent fall in the rate of inflation

Question 19

Deflation

Answer 19

a persistent fall in the level of prices

Question 20

What are the consequences of inflation?

Answer 20

• Greater uncertainty: what will prices
  do in the future?

• Decrease in purchasing power:
people can buy less due to higher
prices.

• Less savings: people want to spend
money now, because it is decreasing
in value.

• Damage to export competitiveness:
foreign countries will buy less goods
from the country that has inflation
due to increasing prices in this
country

Question 21

What are the consequences of deflation?

Answer 21

• Deferred consumption: consumers
  will wait to spend money, because
  prices are decreasing: goods bought
  in the future will be cheaper.

• High level of cyclical
unemployment: less consumption
will lead to less production and
therefore causes unemployment.

• Bankruptcies: less consumption will
cause profits of firms to decline. This
may result in them having to shut
down.

Question 22

Demand pull inflation.

Answer 22

A type of inflation caused by an increase in AD

Question 23

Cost push inflation.

Answer 23

A type of inflation caused by a fall in AS, in turn resulting from increases in cots of production. (only occurs in the classical model)

Question 24

How could the government decrease inflation?

Answer 24

• Increase taxes / reduce government spending (fiscal policy): this will cause incomes
  of people to decrease, reducing spending and thus reducing demand pull inflation.
• Raise interest rates: this will cause people to save more (they will get more interest) and
  spend less, this reduces demand pull inflation.

-Reduce money supply (monetary policy): when there is less money in circulation, the
value of money will increase. So less money is needed to buy something and the
price is reduced.

• Supply-side policies – shift supply curve to the right: (e.g. education, invest in
  technology etc.) this will reduce the cost for producers, reducing cost-push inflation.

Question 25

What are the consequences of economic growth?

Answer 25

- Increase in living standards, due to higher GDP per capita, increase in wealth. • Decrease in unemployment, more workers needed for the increased production. • Possible increase in inflation; when caused by a higher demand prices may rise due to demand pull inflation. • Possible reduction in inequality (using taxation). Governments can increase their tax revenue and redistribute more. • Increase in exports and imports: more production may lead to a higher export potential, more demand may lead to a higher import potential. • Possible increase in sustainability. When GDP is growing there is more money available to work on sustainable technologies / when GDP growth is caused by technological advance, part of that technological advance may be used for a more sustainable production. • Possible decrease in environment: a higher GDP means production has increased. Production may be polluting the environment.

Question 26

What does equity mean?

Answer 26

fair distribution of income.

Question 27

Equality

Answer 27

equal distribution of income.

Question 28

How do you promote equity?

Answer 28

Taxation to redistribute income: • Direct vs. indirect taxes – Direct: imposed directly on income, wealth and profit. (e.g. income tax) – Indirect: imposed over consumer spending (e.g. VAT) • Progressive, regressive and proportional taxation – Progressive: the higher the income, the higher the average tax rate. – Regressive: the higher the income, the lower the average tax rate. – Proportional: same tax rate for all incomes. Direct government expenditures: • Provide money directly to people • Subsidies (e.g. subsidize certain sectors in order to employ more people). Transfer Payments : (e.g. unemployment benefits, pensions)

Question 29

What are the arguments for income redistribution

Answer 29

1. Taxes are important revenue for the government 2. Taxes can help reduce market failure (see microeconomics). 3. Redistribution makes the distribution of income more fair

Question 30

What are the arguments against redistribution?

Answer 30

1. Full efficiency can only be reached without government intervention 2. Taxes may discourage people to work or engage in entrepreneurial activities 3. Taxes have negative effects on growth 4. Transfer payments cost a lot of money which could also be used elsewhere

Question 31

Absolute Poverty

Answer 31

the inability to fulfill the basic economic needs.

Question 32

Relative poverty

Answer 32

being poor relative to others around you.

Question 33

What are the causes of poverty?

Answer 33

- Low incomes • Unemployment • Lack of human capital, not having enjoyed enough education may lead to unemployment and low incomes.

Question 34

What are the consequences of poverty?

Answer 34

- Low living standards • Lack of access to health care and education

Question 35

fiscal policy

Answer 35

government intervention by either adjusting taxes or adjusting government spending

Question 36

Expansionary fiscal policy

Answer 36

- Reducing taxes • Increasing government spending • AD increases: a move from AD1 to AD2

Question 37

contractionary fiscal policy

Answer 37

* Increasing taxes * Decreasing government spending • AD decreases: a move from AD1 to AD3 .

Question 38

How does fiscal policy promote long term economic growth?

Answer 38

- Government expenditure can help to create an economic environment favorable to investment. (e.g. investing money in infrastructure). Making the the economy more stable. • Direct investments by the government may lead to a more efficient production (e.g. by providing companies with the means to do more research & development)

Question 39

What makes up government revenue?

Answer 39

-Taxes • Sale of goods and services (e. g. by companies that belong to the government) . • Sale of state owned enterprises

Question 40

what makes up government expenditure?

Answer 40

Current expenditures = recurring expenditures (e.g. wages of civil servants, interest on government debt). • Capital expenditures = one-time payments (e.g. building a new school). • Transfer payments = payments to citizens (e.g. welfare, pensions).

Question 41

Monetary policy

Answer 41

government intervention by adjusting interest rates or | money supply

Question 42

Expansionary monetary policy

Answer 42

- Increasing the money supply, this will decrease the price paid for money (which is interest) so interest rates will decrease. • AD increases: a move from AD1 to AD2 .

Question 43

contractionary monetary policy

Answer 43

- Decreasing the money supply, this will decrease the price paid for money (which is interest) so interest will decrease. • AD decreases: a move from AD1 to AD3

Question 44

What are the responsibilities of the central bank?

Answer 44

Controlling inflation * Controlling money supply * Influencing exchange rates * Regulating commercial banks * Controlling interest rates

Question 45

What are supply side policies?

Answer 45

government intervention by affecting the production side of the economy ⇒ changing the quantity or quality of the factors of production.

Question 46

Interventionist supply side policy

Answer 46

-Investment in human capital (e.g. providing education). * Investment in new technologies. * Investment in infrastructure. • Policies that favor industrial companies, e.g. tax cuts, subsidies

Question 47

Market based supply side policy

Answer 47

- Incentive-related policies: involve cutting various types of takes, which are expected to change the incentives faced by taxpayers. - Labour market reforms: Increasing labour market flexibility, intended to make labour markets more competitive, to make wages respond to the forces of supply and demand to lower labour costs and increase employment by lowering the natural rate of unemployment. - encourage competition: greater competition among firms forces them to reduce costs, contributing to greater efficiency in production and improving the allocation of resources, the the possible benefit of improving the quality of goods and services.

Question 48

What are the positives of fiscal policy?

Answer 48

+ Positively affects growth + Ability to target specific sectors + Direct impact on AD + Works well in a recession

Question 49

What are the negatives of fiscal policy?

Answer 49

- It takes time to work (time lag) − Can’t influence the supply side of the economy − Negatively influences government budget − Raise in government spending can increase interest rates ⇒ less consumption and investment (crowding out)

Question 50

What are the positives of monetary policy?

Answer 50

+ Easy to increase interest rates + Interest rates can be increased step-by-step (incrementally) + Positively affects growth

Question 51

what are the negatives of monetary policy?

Answer 51

-Takes time to work (time lag) − Doesn’t work well in a recession − Conflict of interest with inflation targets

Question 52

What are the positives of supply-side policies?

Answer 52

+ Positively affects growth + Creates employment + Reduces inflationary pressure

Question 53

What are the negatives of supply-side policies?

Answer 53

− Takes time to work (time lag) − Can negatively influence equity − May be politically undesirable − May negatively influence the environment

Question 54

what are demand-side policies:

Answer 54

Policies that focus on changing AD, or shifting AD curve to achieve the goals of price stability, full employment, and economic growth.