4.2.3 Economic Performance

Question 1

Define Economic Growth.

Answer 1

-Increase in the real value of goods and services produced as measured by the annual % change in real GDP
- Also defined as a long-run increase in a country’s productive capacity/potential national output

Question 2

Define the Economic Cycle.

Answer 2

• Recurring and fluctuating levels of real output, above and below the trend line of economic growth.

Question 3

State the different stages within the Economic Cycle.

Answer 3

• Boom
• Recession
• Slump
• Recovery

Question 4

Explain what may happen during a Boom, in the Economic Cycle.

Answer 4

• Caused by excess spending
• Inflation may occur
• Shortages of skilled workers
• Business costs rise with inflation

Question 5

Explain what may happen during a Recession, in the Economic Cycle.

Answer 5

• Caused by too little spending
• GDP falls (negative GDP for 2 consecutive quarters)
• Businesses experience falling demands and profits
• Unemployment starts to rise.

Question 6

Explain what may happen during a Slump, in the Economic Cycle.

Answer 6

• Serious and long, drawn-out recession
• Unemployment very high
• Many businesses fail to survive due to lack of demand

Question 7

Explain what may happen during a Recovery, in the Economic Cycle.

Answer 7

• GDP rising
• Unemployment falling
• Country enjoys higher living standards
• Businesses do well

Question 8

State the 2 main groups of causes of the Economic Cycle.

Answer 8

• Endogenous models- try to explain cyclical fluctuations in terms of events, which lie within the economic system
• Exogenous models- argue cycles can be started by outside events, i.e. demand-side or supply-side ‘shocks’ from beyond economic system.

Question 9

State and explain the Benefits of Economic Growth.

Answer 9

• Higher Disposable Income- firms making higher profits, higher wages for workers
• Higher Employment- more demand for a country’s goods + services- increased demand for labour
• Higher profits for firms- if households earn + spend more. Firms can invest in capital, continuous profits, better for economy.
• Fiscal Dividend for Gov (increase in tax revenue)- income tax rise, VAT rises, corporation tax rises, e.t.c. Gov can fund their spending in economy more easily.

Question 10

State and Explain the Costs of Economic Growth.

Answer 10

• Inflation- erode purchasing power, living standards unable to increase as much as they would’ve.
• Income inequality- high incomes may be contained within 1 sector. No income redistributing polices (welfare state policies), then income inequality remains.
• Environmental Costs- negative externalities in production, e.g. desertification, deforestation, e.t.c.
• Current Account Deficit- as incomes rise, sucking in of imports effect- households spend on goods + services abroad.

Question 11

State and explain the Causes of a Recession.

Answer 11

• End of property boom- falling house prices hit wealth, led to large contraction in new house building.
• Reductions in disposable income- due to wages rising less quickly than prices, + rising unemployment
• Time-lag effects of rising interest rates in 2007-08 (done by BoE due to rising food + energy prices, + inflation being over target of 2%.)
• Sharp fall in consumer confidence- made worse by rise in unemployment- leading to rise in saving + decrease in spending.
• External events- such as recession in the UK’s major trading partners including the USA (account for 15% of UK Trade) + the Euro Area (55% of UK trade)
• Uk exports declined, hit manufacturing industry hard

Question 12

Define an Output Gap + Potential Output.

Answer 12

• Economic measure of the difference between the actual output of ann economy + its potential output.
• Potential Output- max amount of goods/services an economy can turn out when its most effective that is, as full capacity.

Question 13

Explain what a Positive Output Gap is and how it is caused.

Answer 13

Occurs when actual output is more than full-capacity output.
- Happens when demand is very high, and to meet demand, factories + workers operate above their most efficient capacity level- can create inflationary pressure- significant economic problem
- AD exceeds LRAS- any increase in SRAS which attempts to meet new demand likely to be unsustainable, creating inflation

Question 14

Explain what a Negative Output Gap is.

Answer 14

• Occurs when actual output is less than what economy could produce at full capacity.
• Negative gap means there’s spare capacity in economy due to weak demand.
• AD insufficient to enable economy to reach full capacity
• Downward pressure on output, employment + price level.

Question 15

Define Demand-Side Shocks.

Answer 15

• Shocks affecting rate of growth of demand in UK + other countries.
• Demand-side shock in 1 country can have demand + supply side effects in other countries, as of inner-relationships between countries in a globalised world.

Question 16

Define Supply-Side Shocks.

Answer 16

• Shocks affecting costs + prices in different countries.
• Can impact directly on SRAS in economy, may also have longer term effects on LRAS.

Question 17

State what can cause a Demand-Side Shock.

Answer 17

• Capital investment boom
• Significant rise/fall in exchange rate
• Consumer boom abroad, affects demand for our exports of goods/services
• Unexpected cut/rise in interest rates (i.e. a ‘policy shock’)- central bank may act deliberately to boost demand through lower interest rates.

Question 18

State what can cause a Supply-Side Shock.

Answer 18

• Changes in oil prices + other energy costs
• Natural disasters, poor weather affecting supplies of agricultural products
• Major increases in the global supply of labour (e.g. the emergence of China, India, Brazil + Russia into the global economic trading system)
• Any shock leading to lower costs of production (technological improvements, lower factor prices, lower taxes, increased subsides) will lead to a rightward shift in AS.

Question 19

Define Unemployment.

Answer 19

Number of people who are actively seeking work, but cannot find a job at a point in time.

Question 20

Explain why measuring Unemployment is important.

Answer 20

• Unemployment represents waste of resources for economy
• High unemployment generally indicator of poor economic performance
• Economies with strong economic growth, likely t have low unemployment

Question 21

Define the Level of Unemployment.

Answer 21

Number of people unemployed.

Question 22

Define and state the equation for the Rate of Unemployment.

Answer 22

• Number of people unemployed as a % of the labour force.
  Rate of Unemployment= (Unemployed / Labour Force) X 100.
• Labour Force includes all those people who are economically active, i.e. willing + able to work

Question 23

How is the Labour Force Survey (LFS) used to measure Unemployment.

Answer 23

• Survey of 60,000 households in UK
• Compiled by ONS (Office for National Statistics)
• Measures unemployment, employment, types of unemployment + economic inactivity
• Uses an internationally agreed erasure- comparable

Question 24

Why is the Claimant Count no longer used to measure Unemployment.

Answer 24

• Diff to compare between countries
• Not everyone will claim, e.g. may feel embarrassed
• Not everyone can claim
• Could be subject to fraud
• Tends to be lower than LFS

Question 25

Explain why low Unemployment is a Macroeconomic policy objective. (target: 3%)

Answer 25

• More people have incomes- rising living standards
• Leads to higher spending + higher growth rates
• Improves gov’s fiscal position (increases ax revenue + reduces spending on welfare)

Question 26

State and Explain the issues with using the LFS to measure Unemployment.

Answer 26

• Sampling Errors- only samples a small portion out of the economically active (60,000)
• Inactive Groups- those of working age who are unwilling to work. Unemployed resource, but won’t be counted as unwilling.
• Under-Employed- counted as fully-employed, even if you have a part-time job/work more than 1 hour per week.

Question 27

State and explain the different types of Unemployment.

Answer 27

• Frictional Unemployment- occurs as workers move between jobs, always likely to be some frictional unemployment that persists in an economy.
• Cyclical Unemployment (Demand-Deficit)- lack of AD in economy- less demand for labour. Associated with recession + slump phases of economic cycle. Recession can lead to hysteresis, remain unemployed due to loss of skills.
• Seasonal Unemployment- workers unemployed at different times of year, happens in seasonal industries, e.g. tourism. Seasonality in employment patterns can distort unemployment figures, unemployment often ‘seasonably adjusted’- smooths out fluctuations in employment levels- more accurate statistics.
• Structural Unemployment- immobility of labour, mismatch between skills workers have + skills needed for available jobs. 2 types: Occupational- workers lost skills/become worthless. Geographical- workers unwilling to move.
• Technological Unemployment- when improved capital (may be more productive + effect client than labour), replaces labour as a FoP.
  -Regional Unemployment- occurs within particular towns, cities, e.t.c. Local area often specialised in production of a good/service that’s no longer demanded
• Casual Unemployment- contract ending, waiting for new contract to begin, e.g. actors, builders, e.t.c.

Question 28

State and explain the consequences of Unemployment for the Economy.

Answer 28

• Lost Output- unemployment represents significant wastage of economic resources and likely economy will be producing within PPF. If there was full employment, economy could produce closer to PPF.
• Increased Gov Spending- on JSA + employment programmes
• Lost Tax Revenue- through lower income receipts. Also likely to be lower consumption, so VAT receipts will fall

Question 29

State the consequences of Unemployment for Firms.

Answer 29

• Reduced demand for goods + services
• Reduced output
• Less incentive to invest as return on investment dependent on demand.

Question 30

State and explain the consequences of Unemployment for the Unemployed.

Answer 30

• Lower living standards- unemployed have lower incomes, meaning reduced standard of living
• Financial costs- looking for work incurs a time cost, more time spent at home can increase utility bills
• De-Skilling- longer you’re unemployed, more ‘de-skilled’ you become as workplace skills aren’t developed, leads to diminishing ‘human capital’ over time.
• Reduced chances of finding work- longer you’re unemployed, less likely you’re to find a job.

Question 31

Define Inflation.

Answer 31

The persistent increase of prices in an economy in a year.

Question 32

State how inflation is measured.

Answer 32

• Consumer Price Index (CPI)
• Retail Price Index (RPI)
  Preferred measure is CPI, measure that forms the Bank of Englands Target (2%)

Question 33

Explain how the CPI is calculated.

Answer 33

• Family expenditure surgery carried out by the Office for National Statistics
• ‘Consumer Basket’ of most popular goods/services formed with average prices attached- represent what average family is buying in a fortnightly period.
• Prices of these goods/services are weighted based on % of income (between 0 and 1, e.g. spending 10% of income= 0.1)
• Example: petrol given high weighting as it forms large part of household expenditure +there are few direct substitutes.
• Weighted prices added to give total weighted price of basket.
• Basket updated by ONS every year to reflect changes in spending patterns.

Question 34

State + Explain the Issues with CPI.

Answer 34

• ‘Average Family’- personal inflation rates always diff, e.g. rich households impacted by change in price of foreign holidays, whereas poor households aren’t- yet basket still risen.
• Price fluctuations of certain goods- e.g. food, energy- weighted heavily in CPI, any price change massively affects overall CPI inflation rate. (not representative of all goods) If the case look at the core CPI value.
• Doesn’t include housing costs- e.g. rent, mortgage interest payments, council tax, e.t.c. For many households mortgage payments are their biggest item of expenditure. If problem look at CPIH.
• Basket updates too slowly- once a year, C habits change much faster. CPI + inflation rates aren’t representative of current consumer habits in economy.

Question 35

State the 3 causes of Inflation.

Answer 35

• Demand-pull
• Cost-push
• Growth of Money Supply

Question 36

Explain Demand-Pull Inflation and why it occurs.

Answer 36

(AD shifts Right)
More pressure on existing FoPs- causes price to rise
AD= C + I + G + (X - M)
- Lower interest rates- cheaper for Consumers to borrow + spend, cheaper for firms to borrow + I, weakens exchange rate- increase X
- Lower income tax- increases disposable income + C. Decrease in Corporation Tax- increases remand profit, for I.
- Higher consumer + Business confidence- boosts C + I
- Weak exchange rate (X - M) WIDEC- reduce import expenditure, boosts export revenue

Question 37

Explain Cost-Push Inflation and why it occurs.

Answer 37

(SRAS shifts Left)
Increase in CoPs, pass costs onto consumers via higher prices.
- Higher prices for raw materials
- Higher wages
- Higher business taxes, e.g. Corporation Tax
- Higher price of imported raw materials due to weaker exchange rate.

Question 38

Explain the Costs of High Inflation.

Answer 38

• Lower purchasing power- wages aren’t rising in line with inflation, lead to lower living standards
• Erosion of savings- interest rates not in line with inflation, S lose value
• Price Spirals- wage price spirals- workers demand higher wages to keep up with inflation. Firms raise prices to cover increases in CoP- adds to inflation + spiral continues. Consumer price spirals- bring forward purchases, before prices continue to rise,drive up C + AD- increase demand-pull inflation.
• Fiscal Drag- workers’ wages rise in line with inflation (no better off). however in new tax bracket- pay higher tax, decrease living standards. Good for gov, bad for consumers.

Question 39

Explain the Benefits of Low + Stable Inflation.

Answer 39

• Workers with higher wages- bargain higher wages, even if only in line with inflation
• Firms encourage to increase output- if inflation is low + sable,firms can increase prices + earn more revenue
• Reduces real value of debt- wages, profits + revenue rise- easier to pay off debt
• Improvement of gov finances- any taxes based on nominal values rise- gov collect more revenue

Question 40

Define Deflation.

Answer 40

Persistent fall of prices in an economy in a year
- Inflation is negative

Question 41

Explain Demand-Side Deflation and its effects.

Answer 41

(Malignant Deflation)- AD shifts left
- Comes with lower growth
- Long-term + anticipated
- Delayed spending- consumers buy when prices are even lower- C falls now- reduces AD- lower growth + higher unemployment
- Increased real value of debt- prices falling, profits + incomes fall, harder to service debt, e.g. mortgage payment doesn’t fall a long with falling incomes.

Question 42

Explain Supply-Side Deflation + its effects.

Answer 42

(Benign)- SRAS shifts right, reduction in CoPs
- Higher economic growth
- Short-term + unanticipated- lower raw material prices, stronger exchange rate, e.t.c. (short-term factors)
- Falling prices for consumers- rising living standards, as purchasing power increases
- Falling input prices for firms- reduces CoPs, widening profit margins.

Question 43

Define Disinflation.

Answer 43

Slowing rate of increase in general price level of goods + services in economy over time.

Question 44

Define Balance of Payments.

Answer 44

Record of a country’s trade/transactions with the rest of the world

Question 45

State the main component of the Balance of Payments

Answer 45

Current Account:
- Trade in Goods
- Trade in Services
- Investment income
- Transfers
Add all values to get current account- negative value=account deficit (is in UK). positive value= account surplus

Question 46

Explain Trade in Goods, in respect to the BoPs.

Answer 46

• Measures net exports of visible goods
• UK traditionally run large deficit on trade in goods component of BoP
  This is because:
• Increase in demand for consumer goods, many of which have to be imported
• Decline in UK manufacturing sector as secondary production is outsourced to low wage economies
• Strong currency- makes imports of goods more affordable + exports less attractive to foreign buyers

Question 47

Explain Trade in Services, in respect to BoPs.

Answer 47

• Measures net exports of invisible items (e.g. banking, insurance, tourism, e.t.c.)
• UK traditionally run large surplus on Trade in Services component of Current Account
  This is because:
• UK seen shift away from primary + secondary sectors towards tertiary sector unemployment, thus specialising in provision of services
• Specialisation meant UK more competitive in provision of these services- can offer better services at lower cost
• Example: London’s developed as one of the world’s prime financial centres + become major source of income + wealth generation in UK

Question 48

Explain Invest Income, in respect to BoPs

Answer 48

• Generated by UK opened overseas assets
• Example: UK firms may own company abroad, or generate income from overseas investments- profits + dividends received are sent back to UK, count as a credit item of I income on current count
• However, debt items also occur as foreign investments into UK may yield profits which are sent back to country of investment origin.

Question 49

Explain Transfers, in respect to BoP.

Answer 49

• Payments made (or received) usually by gov, to or from other countries
• Main transfer is now Foreign Aid

Question 50

State and explain the Demand-Side Causes of a Current Account Deficit.

Answer 50

• Strong domestic growth- incomes + living standards high, people more likely to buy imports (increase import expenditure) worsen current account
• Recession overseas- incomes abroad fall- demand for our exports decreases (export revenue declines) worsen current account
• Strong exchange rate- imports cheaper, exports more expensive (SPICED)

Question 51

State and explain the Supply-Side Causes of a Current Account Deficit.

Answer 51

More destructive than demand-side, as long-term
- Low I
- Low productivity
- High relative inflation
- Poor quality
- Depletion of resources

Question 52

Explain the Consequences of a Current Account Deficit.

Answer 52

(X - M) negative- decreases AD + shifts left
- Shows reduction in growth
- Increase in unemployment (as less demand for labour + resources)

Question 53

State + explain how we can redress the BoP, so that it is no longer in deficit.

Answer 53

• Controlling consumer will spending- will reduce demand for imports, may improve BoP
• Investing in supply-side of economy- improve productivity of UK firms in terms of quality + price competitiveness. Enhanced productivity measures may lead to higher exports through greater output
• Depreciation of exchange rate- make our exports more price competitive, However, will increase relative price of imports, problematic if we can’t produce alternatives domestically
• Improve overall macroeconomic conditions in UK- encourages I + domestic growth, as well as reducing reliance on imports.

Question 54

Explain the arguments for whether a persistent BoP deficit matters or not.

Answer 54

Yes it does, because:
- Risk of Capital I- continued large BoP deficits may cause foreign investors to lose confidence + withdraw their I. Cause issues with unemployment + reduced production capacity for economy, may lead to big impact on exchange rate.
- Indicates unbalanced economy- a lot of UK growth based around consumer spending + development of service sector, with little I in manufacturing can leave economy at risk of external shocks + deep recession if there’s downturn in services sector.

No, it doesn’t because:
- Increased economic growth- If I by firms is encouraged by gov + is funded largely through increased borrowing, fine if results in economic growth, increased employment, increased productivity + increased international competitiveness.
- If indicates strong economy- if level of imports is result of economic growth, as firms require more supplies of raw materials, economy moves towards a boom- firms expand + increase profits, more people employed- higher wages. Consequently, gov revenues increase

Question 55

Explain the difference between short-run + long-run growth.

Answer 55

• Short-run growth is the % increase in a country’s real GDP + is usually measured annually. Caused by increases in AD.
• Long-run economic growth occurs when the productive capacity of economy is increasing + refers to the trend rate of growth of real national output in an economy over time. Caused by increases in AS.