4.2.3

Question 1

What is economic growth?

Answer 1

Economic growth is an increase in rGDP in an economy in a year caused by an increase in AD or LRAS.
SR Growth is when AD increases, using the spare capacity within the economy and moving closer to the full employment level of output. This can occur whenever AD shifts to the right.
LR Growth is when there is an increase in LRAS, meaning there is an increase in the productive capacity of the economy. This can be shown by LRAS shifting right, resulting in the full employment level of output increasing. This can be caused by an increase in the quantity/quality of the factors of production or an increase in productive efficiency.

Question 2

What is the economic cycle?

Answer 2

The economic cycle shows the economic growth within an economy over time, showing both the actual growth and trend rate of growth. It can also show both booms and troughs, demonstrating when there are negative/positive output gaps. The 4 different stages of the economic cycle are: boom, recession, trough and recovery.
In a boom, growth is faster than trend rate, with there being a positive output gap. This can result in very low unemployment, high consumer and business confidence resulting in great investment and spending. However, there can be significant demand pull inflation
In a recession/trough there will be a negative output gap, higher unemployment and low confidence.
In a recovery there is likely rising confidence and rising investment/spending. There can also be the use of expansionary policy from the government in order to stimulate AD back to trend rate levels.
The reason for the fluctuating economic cycle is demand and supply side shocks. These are factors that cannot be foreseen and shift macroeconomic equilibrium, pushing an economy into recession.

Question 3

What are the benefits of economic growth?

Answer 3

• Higher disposable incomes, firms may pay higher wages or workers may come out of unemployment.
• Higher employment as firms need more firms to match the greater output
• Higher profits for firms
• Fiscal dividend for the govt. As they receive greater tax revenues.

Question 4

What are the costs of economic growth?

Answer 4

• Inflation
• Income inequality
• Environmental costs
• Current account deficit

Question 5

Economic growth eval

Answer 5

• Sustainable growth is desirable
• Inclusive growth benefiting everyone
• Balanced growth spread across the economy
• Role of the govt to ensure the correct policies are in place
• SR vs LR

Question 6

What is unemployment and how is it measured?

Answer 6

The unemployed consist of those of working age, who are willing and able to work, actively seeking work but do not have a job.
There are 2 ways of measuring unemployment:
-Labour Force Survey
-Conducted by the ONS whereby households are surveyed on their current employment status
-Claimant Count
-Uses the amount of people claiming JSA to work out the amount unemployed. However, not all workers will claim JSA and it is difficult to compare between countries.

Both methods are subject to sampling errors and high costs.

Question 7

What are the types of unemployment?

Answer 7

• Cyclical - When there is a lack of AD, resulting in a lack of demand for goods and services, lowering the derived demand for labour. Any time rGDP falls in the economy, there will be a rise in cyclical unemployment
• Structural - Where the immobility (either geographical or occupational) of labour results in unemployment. The workers will either lose their skills or no longer have the desired skills to work (occupational). Or, workers may be unwilling or unable to move to be employed (geographical).
• Frictional - Those unemployed who are in between jobs after leaving one and searching for a new position.
• Seasonal - Those unemployed due to a lack of demand during a specific season

Question 8

What are the costs of unemployment?

Answer 8

• Lost output - workers not working is wasteful
• Deterioration of govt finances - increased welfare payments, less tax revenue
• Hysteresis - workers becoming discouraged to gain work due to them always being turned away - results in them being deskilled and dropping out of the labour force
• Social Costs - High crime, divorce, depression
• Reduced trade in other countries
• Lost income
• Lower standard of living

Question 9

What are the benefits of unemployment?

Answer 9

• Firms benefit from greater choice of workers

- Workers have time to search for the best job for them

Question 10

Unemployment eval

Answer 10

The effect of unemployment will depend on:

• The type of unemployment - How long are workers unemployed for? - The longer workers are unemployed, the worse the costs are.
• How severe is unemployment - Is it at the NRU?
• The level of welfare payments - welfare payments can reduce some costs such as lost income or lower standard of living. - High cost and could dis-incentivise work.

Question 11

What is inflation?

Answer 11

Inflation is the persistent increase of prices in an economy in a year. Disinflation is where prices are rising, although slower than previously. Deflation is where prices are falling.
Inflation is measured using CPI. This uses a ‘consumer basket’ of the most popular goods/services and the prices of these goods are weighted based on the percentage of income they constitute. These weighted prices are added together to give the weighted price of the basket. By repeating this over many years, a base year can be set and index numbers can be used to compare prices over many years.
Demand pull inflation is caused by a right shift of AD.
Cost push inflation is caused by any left shift of SRAS.

Question 12

What are the outcomes of deflation?

Answer 12

Demand side deflation (left shift of AD) can be very bad. This is due to it resulting in a fall in rGDP, giving lower growth, and could also lead to long-term/anticipated deflation. This deflation could result in a recession, which would also bring further deflation.
Supply side deflation (right shift of SRAS) can be good. This comes with higher growth and the deflation is short-term/unanticipated.
Anticipated deflation could lead to delayed spending, positive real interest rates and increased real value of debt.
Short term deflation could lead to falling prices for consumers and falling input prices for firms.

Question 13

What are the costs of inflation?

Answer 13

• Reduced purchasing power
• Menu costs - reprinting of menus and other items as prices change
• Fiscal drag - Pay rises to match inflation may push workers into higher tax bands, reducing real disposable incomes.
• Reduced international competitiveness - higher prices - SPICED
• Uncertainty - reduced confidence - reduced investment and expenditure
• Effect on savers - inflation erodes the value of savings so savers suffer

Question 14

What are the benefits of inflation?

Answer 14

• Workers can demand higher wages - even if it is only to match inflation it can boost morale.
• Incentivises production
• Low and stable inflation will incentivise healthy consumption habits.

Question 15

Inflation eval

Answer 15

• What is the cause? - Cost push or demand pull
• How long does it last?
• Is it anticipated?
• How severe is the inflation? - is it above target

Question 16

What is the quantity theory of money and fisher’s equation?

Answer 16

Quantity theory of money shows there is a direct link between money supply and inflation.
Fisher’s Equation: MV=PQ
M - Money supply
V - Velocity of circulation
P - Average price level
Q - Quantity of goods/services sold

Question 17

What is the SRPC?

Answer 17

The PC shows that there is a macroeconomic conflict between employment and inflation. As unemployment is low, wages will rise quickly as workers are scarce and have greater bargaining power. However, in times of high unemployment, wages may fall resulting in less inflation.
A shift in AD will result in a contraction/expansion along the SRPC.
A shift in SRAS will shift the SRPC in the opposite direction. This can be used to show times of stagflation (high inflation and unemployment).

Question 18

What is the LRPC?

Answer 18

If there were a right shift in AD, eventually workers would demand higher wages, shifting SRAS left and back to Yfe. This would shift the SRPC right, resulting in the economy working at the same unemployment level (the NRU). Connecting this vertical line gives the LRPC. The LRPC shows that, in the long run, the economy will always return back to the NRU and NAIRU. The NAIRU (Non Accelerating Inflation Rate of Inflation) is the rate of unemployment at which the rate of inflation is stable.