Chapter 11 Flashcards
1
Q
What is short run economic growth?
A
Growth caused by increases in utilisation of unemployed resources. Percentage change in real national output = actual growth.
2
Q
What is long run economic growth?
A
Growth caused by an expansion of an economy’s productive capacity or potential. Is an increase in trend rate of growth.
3
Q
How can short run economic growth be achieved?
A
Through changes in gov policy
Increases in SRAS
Increases in AD and occurs when unemployed factors are brought into producing output
Note: Where one of the factors of production is fixed, usually capital.
4
Q
How can long run economic growth be achieved?
A
Anything that increases in LRAS - like increases in labour force (labour supply), which can be achieved by:
1. Encouraging participation from the economically inactive
2. Decreasing the attractiveness of remaining unemployed
3. Increasing the retirement age/decreasing school leaving age
4. Encouraging immigration/discouraging emigration
5. Improving labour productivity
6. New tech
7. Education - improving productivity or occupational mobility
8. Gov policy - supply-side policies
5
Q
What is long run economic growth also called?
A
Trend growth
6
Q
Define economically inactive
A
Those of working age not in employment or looking for work
7
Q
What are the 7 benefits of economic growth?
A
Higher living standards
Easier to find jobs
Social indicator improvements
Increase tax rev
Lower welfare expenditure
Lower absolute poverty
Status and prestige for the gov
8
Q
What are the 4 disadvantages of economic growth?
A
Increases in negative externalities (i.e. pollution, increased congestion on road)
Potential increases in inequality for the low skilled workers
Higher wages from promotions causing increased stress and reduced productivity
Natural resource depletion - therefore isn’t sustainable for future gens
Increases in inflation - demand pull (rise in demand > supply) or cost push (demand for resources rises causing less supply)
9
Q
Explain the environmental impact of growth
A
Sustainable growth may avoid some of the negative costs of economic growth.
Gov can encourage sustainable growth through taxes, subsidies and regs
10
Q
What are the 4 stages of the economic cycle?
A
Boom, Downturn, Recession, Recovery
11
Q
What is the economic cycle?
A
The repeated fluctuations in short-term growth over time
12
Q
What is trend growth?
A
The expansion of the economy’s productive capacity over time
13
Q
What is the output gap?
A
The difference between actual growth and trend growth
14
Q
What is a boom?
A
Where the economy is growing quickly and unemployment is low, so rising AD causes inflation to rise.
15
Q
Explain the 6 features of an economic boom
A
- Above average economic growth
- Unemployment falls, reaching low levels
- Inflation rises as economy ‘overheats’
- High consumer/business confidence
- Budget balance moves into surplus/ smaller deficit
- Current account balance moves into deficit/ deficit increases
16
Q
Explain the 6 features of an economic downturn
A
- Economic growth falls (but still positive)
- Unemployment stops falling (but may not rise yet due to labour hoarding)
- Inflation is high but stops rising
- Consumer/ business confidence falls
- Budget balance moves towards/further into deficit
- Current account balance moves towards surplus/smaller deficit
17
Q
Explain the 6 features of an economic recession
A
- Economic growth is very low or negative
- Unemployment rises quickly, reaching high levels
- Inflation falls, reaching low levels (with possible deflation)
- Low business confidence = less investment
- Budget balance moves further into deficit
- Current account balance moves towards/into surplus
- Firms increase efficiency due to needing to cut costs to survive
- Discount retailers demand rises as consumer confidence is low.
18
Q
Explain the 6 features of an economic recovery
A
- Economic growth is positive but below average
- Unemployment remains high but may stop rising
- Inflation remains low but stops falling
- Consumer/ business confidence is low but begins rising
- Budget balance remains in deficit but deficit will not increase
- Current account balance remains in surplus but doesn’t grow/may begin to move into deficit
19
Q
What is a recovery?
A
Where the economy goes from negative growth to positive growth, so unemployment will fall, causing AD to rise = inflation will also rise therefore.
20
Q
What is a recession?
A
Negative growth for 2 consecutive quarters, so unemployment rises causing AD to fall and price levels to fall.
21
Q
What is the length of each stage of the economic cycle?
A
Not fixed - it’s variable.
22
Q
What happens when positive output gap: actual growth > trend growth?
A
Unemployment probably falling
Inflation probably rising
23
Q
What happens when negative output gap: actual growth < trend growth?
A
Unemployment probably rising
Inflation probably falling
24
Q
What are the explanations of the economic cycle?
A
Multiplier-accelerator model
Inventory cycle
Asset price bubbles
Herding
Excessive growth in credit
Economic shocks
25
Explain employment and unemployment
Full employment refers to the lowest level of unemployment practically achievable. UK aim is around 2%
Unemployment in the UK is measured by: The Claimant Count, Labour Force Survey
26
What are the types of unemployment?
Seasonal, Cyclical, Frictional, Structural
27
What are the causes of seasonal unemployment and the policy to reduce this?
Seasonal decline in demand for output of seasonal industries.
Fix:
This is not a major concern of the gov
28
What are the causes of cyclical unemployment and the policy to reduce this?
Insufficient AD
Fix:
Boost AD with:
- Lower interest rates
- Lower taxes
- Higher gov spending
29
What are the causes of frictional unemployment and the policy to reduce this?
People moving into and out of employment.
Fix:
Improving info about job vacancies and ensuring the welfare system doesn't create incentives to remain unemployed
30
What are the causes of structural unemployment and the policy to reduce this?
Geographical immobility (regional unemployment)
Occupational immobility
Global factors - competition from low-cost producers overseas
Fix:
Supply-side policies
31
What is unemployment also caused by, apart from the 4 main areas?
Demand-side and supply-side factors
32
Define cyclical unemployment
Unemployment caused by insufficient aggregate demand
33
Define frictional unemployment
Unemployment caused by movement in and out of employment by workers
34
Define structural unemployment
Unemployment caused by mismatches in labour demand and labour supply
35
Define voluntary unemployment
Where people choose to remain unemployed at the going wage rate (frictional unemployment may be voluntary)
36
What is involuntary unemployment?
Where people cannot find employment at the current wage rate (cyclical unemployment).
Structural unemployment may be voluntary or involuntary and depends on value judgements made by economists
37
What is real wage unemployment?
Unemployment caused by real wages remaining above the free market equilibrium level
38
What is the natural rate of unemployment?
Unemployment that remains when cyclical unemployment is 0
39
What causes a demand-side factor?
Low AD (cyclical unemployment)
40
What causes a supply-side factor?
Issues of LRAS (i.e. frictional and structural factors)
41
When does real wage unemployment occur?
When real wages exceed the free market wage rate and cannot fall to restore labour market equilibrium.
It can be caused by:
high min wages
trade unions pushing wages up
wages being sticky downwards (i.e. difficulties for businesses in cutting wages)
42
What is the natural rate of unemployment also referred to as?
Full employment
43
Explain the features of full employment
No cyclical unemployment exists
Consists of voluntary, frictional and structural factors
44
What are the causes of frictional factors of unemployment?
Unemployment benefits too high
Replacement ratio is too high (replacement ration > 1 means income from being unemployed is greater than income from employment)
45
How can the replacement ratio be calculated?
(Out of work disposable income)/ (In work disposable income)
46
How can the replacement ratio be lowered?
Less generous unemployment benefits
Min wage increases
Tax credits (allowing people in work to keep some of their benefit payments)
47
What are the causes of structural factors of unemployment?
1. Regional unemployment exists if people are unwilling/unable to move to job vacancies. Can be due to:
- lack of knowledge of vacancies
- difficulties accessing housing in expensive areas
- family ties
- poor transport links
2. People may need training in new skills before they are able to accept job vacancies
- Declining industries required different skills from new, growing industries
- Training takes time to arrange and may not sufficiently provided to ensure people obtain the necessary training to fill vacancies
48
Explain the voluntary factors of unemployment?
People may 'choose' to be voluntarily unemployed. The natural rate of unemployment can be reduced through creating policies to reduce:
- voluntary unemployment
- frictional unemployment
- structural unemployment
49
What are the consequences of unemployment?
Individual ill-health
Family breakdown
Higher crime (possibly)
Economy doesn't operate on it's PPC (PPF)
A larger budget deficit due to higher gov expenditure on welfare and less tax rev being collected
Deskilling of working population (hysteresis)
50
What are the causes of demand-pull inflation?
Caused by excessive increases in AD, each time leading to higher inflation.
Caused by AD rise above that needed to generate 'full employment' output.
51
How can demand-pull inflation be reduced?
Reducing spending by gov
Raising taxes
Raising interest rates
52
What are the causes of cost-push inflation?
Caused by increases in production costs, seen by the leftward shift of the SRAS curve.
Increases in production costs are caused by increased in wages, material costs, power costs, and indirect taxes (VAT etc) and falls of the exchange rate (leading to 'imported inflation')
Cost-push inflation is accompanied by falling GDP (and hence rising unemployment)
53
How can cost-push inflation be reduced?
Higher interest rates - leading to exchange rate rises
Improvements in labour market flexibility (i.e. decrease in trade union power)
54
Define inflation
Percentage change in the price level measured over a period of 1 year
55
Define demand-pull inflation
Inflation caused by excessive increases in AD
56
Define in cost-push inflation
Inflation caused by increases in the costs of production
57
Explain the quantity theory of money
Based on the Fisher equation. It's an alternative explanation for inflation and is favoured by monetarist economists.
58
What is the Fisher equation?
MV = PQ, where M = money supply, V = velocity of circulation (how fast money changes hands), P = price level, Q = real national output
59
According to the Fisher equation, If V is constant and Q grows at the trend rate of growth (assumed to be reasonably constant at around 2% per year), then what is any inflation caused by?
Money supply growth
60
What are the limitations of the Fisher equation?
V is not constant
M cannot be controlled easily due to the global nature of the financial markets
Q doesn't grow at a constant rate over time
The causation doesn't necessarily flow from M to P (i.e. changes in M may not cause changes in P)
Extra:
The quantity theory of money was used in the late 1970s/early 1980s, but has fallen out of favour since.
61
What are the consequences of inflation?
Menu costs
Shoe leather/search costs
Uncompetitive exports
Fiscal drag - people may get pulled into higher tax bands
Uncertainty
Policy response - gov is likely to raise interest rates if inflation rises
62
Explain the expectations and changes in the price level with inflation?
The current rate of inflation is affected by people's expectations of future inflation. Expectations of inflation and actual inflation are connected through wage claims.
People base wage claims on real wages and inflation expectation (i.e. for a real wage increase of 2% with inflation expected to be 3%, workers will push for a nominal wage increase of 5%).
If people expected inflation to increase in the future, they will ask for higher wage rates to compensate.
63
What are the two types of deflation?
Benign/good deflation
Malign/malovent/bad deflation
64
Define the term deflation
A fall in price level measured over a period of time
65
Define the term disinflation
A fall in the rate of inflation
66
Explain benign/good deflation
It's caused by increases in AS.
Caused by advances in tech, falls in input prices (i.e. oil prices), rising productivity
Leads to higher output and lower prices
67
Explain malign/malevolent/bad deflation
Caused by decreases in AD.
Falls in AD leading to deflation are often as a result of falling confidence and a demand-side shock
Leads to lower output (and likely rises in unemployment) and lower prices
68
What are the consequences of deflation?
Delays in consumption - with falling prices, consumers may delay spending which can lead to a deflationary spiral
Rising real value of debt - debt is fixed in nominal terms and therefore increases in size relative to the income of borrowers if prices and incomes are falling
Sticky wages - business may try to cut wages to save money. Workers resist nominal wage cuts and this may lead to industrial conflict and possibly higher real wage unemployment
69
What is the UK's inflation target?
2%, plus or minus 1% (i.e. 1% or 3%)
70
High inflation causes what in an economy?
Economic problems.
Deflation can be good or bad for an economy, depending on the type of deflation.
However, even good deflation can turn into bad inflation if it leads to falling AD.
71
Explain commodity prices and inflation
Commodity prices are often volatile.
Oil prices sig affect the inflation rate due to oil's importance as a business input.
72
Cost-push inflation is more difficult to control than what?
Demand-pull inflation
73
What is the impact of other economies on UK inflation?
Growth overseas increases demand for UK exports and increases demand-pull inflation
Recession overseas decreases demand for UK exports and leads to lower demand-pull inflation
Increased growth overseas (especially in large economies such as China) may lead to rising commodity prices, which lead to cost-push inflation
Changes in overseas economies may lead to changes in the UK exchange rate, affecting cost-push pressures
74
Explain the short run Phillips curve
The short-run Phillips curve (SRPC) shows the apparent trade-off between inflation and unemployment. As unemployment falls, trade unions have more power to push up wages - especially as labour shortages emerge.
If wages rise, then inflation will also rise = the trade off.
To reduce inflation, AD is reduced and this leads to lower GDP and higher unemployment.
This relationship broke down the UK in the 1960s, as actually both inflation and unemployment rose at the same time.
75
Explain the long run Phillips curve
Unemployment/inflation trade-off only occurs in the short run.
In the long run, unemployment rate returns to the natural rate of unemployment.
As unemployment falls, and wages rise, firms reduce employment and unemployment rises back. eventually, the economy settle on a new SRPC where inflation expectations are now higher.
In the long run, the Phillips curve is vertical at natural rate of unemployment, and unemployment is only reduce through policies lowering the natural rate of unemployment.
76
What is often used instead of the natural rate of unemployment?
NAIRU - Non-accelerating inflation rate of unemployment.
At NAIRU, inflation will neither rise or fall
77
Define NAIRU
Is the unemployment rate where inflation is constant
78
What are some policy conflicts with inflation?
Reducing output gaps (+ve and -ve) may conflict in aiming for low unemployment and low inflation.
Other policy conflicts exist -
- between increased economic growth and achieving balance on current account
- between increased economic growth and achieving equitable distribution of income
79
How can policy conflicts be resolved with inflation?
Policies that increase or decrease AD often lead to conflict.
Low inflation and balance on current account are helped by low AD
Low unemployment and high economic growth are helped by high AD
Supply side policies help to resolve the conflict, although they also create conflict with achieving equitable distribution of income.
80
Instability can also be caused by Animal Spirits. Explain this theory.
Classical economists believe that economic agents act rationally, whilst Keynesian economists believe they act irrationally - they believe that humans are guided by instinct and emotion (animal spirits)
81
How does animal spirits theory explains excessive growth in credit and levels of debt?
When credit is cheap and consumer confidence is high, they spend more and accumulate debt.
This can increase AD, leading to higher inflation, causing higher interest rates, reducing investment
High levels of debt mean if consumers lose confidence, they will spend less
82
How does animal spirits theory explain destabilising speculation and asset price bubbles?
Speculation is when people buy assets in the hope to sell them for more.
Speculators assume an increase in price of asset means that it's price will continue to increase in the future, leading to more buying and further price increase.
This can lead to asset price bubbles where price is way above the TRUE VALUE of the asset.
The bubble bursts eventually and the asset's price fall and people's confidence falls = so they sell more, lowering price further. The fall in house prices causes consumers to save instead of spend, causing a downward spiral in the economy.
83
Why is sustainable growth difficult to acheive?
Sustainable growth is economic growth that doesn't affect future gens.
The objectives they want to achieve all at the same time are:
- expand output each year
- find continuous supply of raw materials (land/labour)
- reduce negative externalities (pollution)
Achieving these at same time - very hard, but will increase countries' confidence about long term plans. Countries need to:
- develop renewable resources
- develop new tech to reduce negative externalities
84
From 2000 to 2008, UK enjoyed what?
continuous GDP growth of under 3% each year
85
In 2008, what happened to the UK economy?
A recession occurred for several months, followed by slow recovery. The recovery had short rises and falls in growth.
86
In 2014, what was the GDP level for the UK economy like?
The same as before the recession
87
Inflation has been between what from 2000 to 2015?
0.5% to 3.0%
88
Unemployment has remained low, between 2000 and 2008, with what figures?
1.4m to 1.7m
89
The UK was economy dominated by service sector, which account for what amount of GDP?
77%
