Economics Theme 4 Flashcards

Question

What are 7 reasons for restrictions on free trade?

Answer 1

1. Protecting local industries (Infant/Sunset) 2. Preventing 'dumping' 3. Protecting jobs 4. Less dependency 5. Correct current account deficit 6. Avoid competiton 7. Retaliation

Answer 2

1. Tariffs 2. Quotas 3. Subsidies 4. Non-tariff barriers

Answer 3

Tariffs raise the price of imports. This makes them appear more expensive to consumers, which may lower demand for imports. If this happens, imports will decline. Tariffs also provide additional revenue for the government. Higher prices for consumers Producer surplus increases for domestic producer Welfare loss

Answer 4

This is a direct measure to restrict imports, as it does not allow more than a given amount of imports into a country. But this does not raise any tax revenue for the government. Also, since it is an external intervention – and the price mechanism is not allowed to function naturally – imposing quotas does lead to shortages. Incentivises domestic suppliers to increase supply/enter market

Answer 5

Subsidies are grants given to local producers from the taxpayers’ money. These are given out so that the cost of production can be reduced, which would lower prices for consumers. This would increase a country’s international competitiveness – thereby, making its exports cheap. China subsidies EV industry -- global leader in EVs

Answer 6

Other measures that restrict trade Import licensing Trade embargo Health and safety regulation Legal and technical standards

Answer 7

There are HIGHER PRICES for consumers as they are unable to buy imports at the cheaper price. It tends to raise the price of domestic producers since goods and services needed for the production of these goods may also suffer from import controls and it limits the competition for domestic producers so they have less incentive to be efficient. Moreover, they suffer from LESS CHOICE.

Answer 8

Domestic producers tend to benefit from import controls since they have less the competition so can sell MORE GOODS AT A HIGHER PRICE than otherwise and they will benefit from measures to increase exports. However, they may suffer from higher costs if there are CONTROLS ON IMPORTS they need for production. FOREIGN PRODUCERS WILL LOSE OUT as they are limited in where they can sell their goods. Inefficient, domestic producers are kept in production, whilst efficient, foreign ones lose out.

Answer 9

Evidence suggests that there is little difference to employment figures. It can be argued that allowing inefficient firms to close would be better for workers in the long run. The market would reallocate resources and create new jobs, with greater security. Following the steel tariffs imposed in America in 2018, it is estimated that 16 jobs will be lost elsewhere for every job gained in the steel industry. (The Economist) However, Argentina has been successful at implementing tariffs which protect jobs

Answer 10

In the short run, governments benefit from protectionist policies as they can gain tariff revenues and they are politically popular. However, it can lead to an inefficient economy which stifles growth.

Answer 11

As the tariff diagram shows, the imposition of import controls results in deadweight welfare loss. It also causes trade wars since the introduction of restrictions often leads to retaliation by other countries. A recent example of this is the US-China trade war, where each country continues to impose more tariffs on the other’s goods. This causes a reduction in trade and a reduction in growth

Answer 12

It has a regressive effect on the distribution of income as the rise in price affects the poorer members of society far more than the well off as it is they are no longer able to afford the products.

Answer 13

Capital Investment (e.g. FDI) Financial investments (e.g. purchasing govt bonds) Speculative capital flows (short term - 'hot money')

Answer 14

Growth in large economies such as India and China has increased the demand for imports globally because of their cheap prices. High inflation rate makes exports expensive and imports cheap. So it leads to an increased demand for imports, which is recorded as a negative entry as money leaves the country. Higher exchange rate makes exports expensive and imports cheap, which increases demand for imports. High domestic growth increases demand for imports. Relatively low productivity of labour/lack of capital investment means that each worker produces less than his/her foreign counterpart. This increases average cost, which makes exports expensive and imports cheap. High levels of consumer demand - if real household spending increases more quickly than the supply side of the economy can deliver then imports will rise + UK has a high-income elasticity of demand for imports

Answer 15

Decrease in imports due to protectionist measures. Decrease in inflation rate makes exports cheap and imports expensive. This increases demand for exports, which is recorded as a positive entry on the current account. Lower exchange rate makes exports cheap and imports expensive, which increases demand for exports. Low domestic growth increases demand for exports. Relatively increased productivity of labour lowers average account, which makes exports cheap and imports expensive. Natural resource abundance Comparative/absolute advantages

Answer 16

1. Expenditure reducing policies: These refer to any policies that would reduce aggregate demand. For example, a deflationary fiscal policy (such as increasing income tax) will reduce people’s disposable income. As a result, demand for imports will decrease. Over time, exports may exceed imports. This will reduce the deficit. 2. Expenditure – switching policies These refer to policies that directly affect the demand for imports. We are talking about trade barriers. For example, imposing a tariff on imports will make imports more expensive. As a result, demand for imports will decrease and consumers will switch towards buying domestic goods and services. 3. Supply-side policies These refer to any policies that directly affect the demand for exports. For example, increased spending on education is likely to increase the quality of export goods and services. Also, it may increase labour productivity. This will reduce the price of exports. All of this will make exports more competitive internationally. Hence, demand for exports will increase.

Answer 17

If imports exceed exports for a long period of time, it becomes hard to finance them in the long run. This involves taking a loan, which could mean reduced government spending to repay the loan. This lowers economic growth. If exports exceed imports for a long time, it means factor inputs have mainly been used to produce export goods. This means that choice for domestic consumers remains low, which can result in lower living standards. Trade Imbalances can cause massive currency fluctuations, which can adversely affect global trade.

Answer 18

Floating Fixed Managed

Answer 19

A free floating system is where the value of the currency is determined purely by market demand and supply of the currency, with no target set by the government and no official intervention in the currency markets. Both trade flows and capital flows affect the exchange rate under a floating system. Most systems are floating, including the UK.

Answer 20

A fixed system is when a government sets their currency against another and that exchange rate does not change. The country can decide to devalue its currency overnight to improve international competitiveness of its industry. One example was the gold standard, where each major trading country made its currency convertible into gold at a fixed rate. Today, no country uses the gold standard.

Answer 21

Managed floating is where the value of the currency is determined by demand and supply but the Central Bank will try to prevent large changes in the exchange rate on a day-to-day basis. This is done by buying and selling currency and by changing interest rates. Some examples include the Brazilian Real, Swiss Franc and the Japanese Yen.

Answer 22

1. State of the economy (confidence - investment flows - appreciation in pound). 2. Relative inflation rates (High relative inflation - UK exports more expensive - demand falls - less demand for pounds - depreciation). 3. Relative interest rates (hot money flows). 4. Quantitative Easing (money supply increases - depreciation). 5. Speculation

Answer 23

Speculation

Answer 24

1. Using interest rates 2. Foreign currency transactions (buying and selling their currency).

Answer 25

1. The Current Account 2. Economic growth and unemployment 3. Inflation rate 4. FDI flows

Answer 26

The Marshall–Lerner condition states that depreciation in the value of a currency will only lead to an improvement in the current account if the sum of price elasticity of demand of imports and exports is greater than one. Otherwise, depreciation will not improve the current account deficit.

Answer 27

The J-curve effect states that any change in the exchange rate will take time to have any impact. Initially, there is deterioration in the current account. This is because in the short run, both exports and imports tend to have an inelastic demand. This means that changes in prices do not have an impact on the demand for export or imports immediately. In the long run, however, demand for both exports and imports is elastic. And this improves the current account balance.

Answer 28

In the short-run, the position on the current account would worsen. In the short-run (or for a commodity) demand for exports is price-inelastic and so whilst a depreciation in the pound woiuld result in cheaper exports, in the SR there will be a less than proportionate increase in the quantity demanded and so total export revenue would fall. A depreciation would also result in dearer imports but since the demand for imports is price inelastic in the SR a rise in import prices will result in a less than proportionate fall in the quantity demanded and so total expenditure would increase. Since total export revenue falls and total import expenditure increases, the position in the current account in the SR (or if demand is price inelastic for another reason) would worsen. If time is the only reason demand is price inelastic then J-curve analysis would show in the LR the position on the current account would improve.

Answer 29

If there is a fall in the exchange rate, demand for exports rises. This means that employment in the export sectors increases. This increases domestic consumer spending as well, as more people begin to earn incomes. Thus, the growth rate of a country will increase. Conversely, if there is an increase in the exchange rate, demand for exports falls. This means that employment in the export sectors decreases. This decreases domestic consumer spending, as fewer people earn incomes. Thus, the growth rate of a country will decline.

Answer 30

If a country is heavily reliant on the import of certain goods, then a fall in the exchange rate will increase inflation in the country. This is because imports appear more expensive when the value of a currency falls, and this means that firms reliant on the imports of certain raw materials or manufactured goods will see a rise in their cost of production. If such firms form a major portion of the GDP, then this is likely to lead to rising inflation.

Answer 31

If there is a fall in the exchange rate, it will make domestic goods and services appear cheaper. Foreign firms will want to take advantage of this (i.e. low cost of production and increased exports) and may invest in countries with falling exchange rates.

Answer 32

Competitiveness refers to the ability of a country to sell its goods and services abroad, determined by the price or quality.

Answer 33

Relative unit labour costs Relative export prices

Answer 34

Relative unit labour costs (heavily dependent on productivity) Relative wage and non-wage costs Relative level of inflation Relative level of regulation Relative level of taxes Relative exchange rates Relative level of investment

Answer 35

High levels of regulation slow down business decisions, making them less adaptable to changes in the global market, and increasing costs.

Answer 36

Investment in infrastructure improves productivity and ensures firms can deliver and produce their product reliably, cheaply and efficiently. Investment in R&D allows firms to develop new higher quality products, and new lower cost production methods.

Answer 37

Export-led growth Low unemployment Current account surplus Attracts FDI However, may become dependent on demand from other countries, making the economy more vulnerable to global economic shocks.

Answer 38

Slow economic growth / recession High unemployment Current account deficit Difficult to attract FDI

Answer 39

Supply side policies

Answer 40

Absolute poverty is defined as living below subsistence. This means that the person is unable to meet their basic needs of food, clean water, sanitation, health, shelter and education. The World Bank uses a measurement based on the number of people living on less than $1.90 per day.

Answer 41

Relative poverty is measured by comparison to the average in the country. In the UK, those with below 60% of the median income are considered to be in relative poverty. In the US, a basket of goods which maintains the average standard of living of society is used. Relative poverty can be seen as one way of measuring income inequality.

Answer 42

An increase in the growth rate of a country may lift many people out of absolute poverty, as this will create more job opportunities. However, as average income increases relative poverty may increase. An increase in economic development will reduce both kinds of poverty, as this is about improvements in health, education, etc. This will enable people to find jobs and earn higher wages and improve living standards. An increase in FDI will create more jobs, which might lift a number of people out of absolute poverty. Increased trade also creates more jobs, which reduces absolute poverty. However, if a country only increases its imports – this is likely to lead to job losses and increase in poverty. An increase in taxes can help reduce poverty. Firstly, relative poverty will fall as average disposable income will fall. This will place some people above the threshold (who were previously below it) because the average income will fall. Increase in taxes many also mean more spending on benefits. This will reduce absolute poverty. De-industrilisation Decline in trade unions + real state benefits

Answer 43

Income is a ‘flow’ concept because it is liquid money that flows from one person to the other. Wealth is a ‘stock’ concept because it cannot flow from one person to the other. It is normally stored in a fixed account.

Answer 44

The Lorenz curve The Gini coefficient

Answer 45

This is a diagrammatic illustration of the distribution of income in a country. It plots cumulative income against cumulative population of a country. And so it depicts what percentage of the population acquire a certain percentage of income. Figure 4 shows that the line of equality is at 45 degrees angle. This means that 20% of the population should have 20% of a country’s total income and so on. The Lorenz curve depicts the inequality within a country. In the diagram above, for example, it shows that 80% of the population only have 50% of the country’s income – while the other 50% is in the hands of just 20% of the population.

Answer 46

Area A / (Area A + B) A is the area between the line of equality and the lorenz curve B is the area below the Lorenz curve

Answer 47

Countries with a progressive tax system tend to have greater income equality. Countries that provide benefits to low income earners have greater equality. Countries with a national minimum wage will be less unequal, as they ensure no one is in absolute poverty. Countries with a sound pension scheme are less unequal, as they ensure that the elderly do not fall into poverty once they retire. Countries with higher standards of education and better training opportunities have workers who can demand a higher wage rate. Countries with strong trade unions tend to be more equal, as trade unions ensure that a minimum level of income is maintained.

Answer 48

Initially any economy is undeveloped but more equal – as people earn similar wages. As it develops, inequality begins to rise. This is because as workers start to move towards the manufacturing sector, the wage gap between these new industrial workers and agricultural workers widens. However, eventually, once an economy has grown considerably it begins to move towards greater equality – but with most people earning higher wages. This is because the government is able to collect more taxes and can spend more on benefits.

Answer 49

Capitalism is about allowing individuals to pursue their goals. It allows firms to follow the objective of profit maximisation. In order to increase profits, firms are willing to hire people with high levels of skill. Such workers, however, demand higher wages, while low-skilled workers get lower wages. This means that workers will be prepared to work longer hours and improve their productivity if they can expect higher wages. This will be good for firms and so this creates income inequality. Similarity, since in a capitalist economy people can privately own assets – they are encouraged to acquire more of them. Existing assets (wealth) can be used to generate further income. For example, renting properties can generate additional income from which more assets can be bought. This means that those with a great amount of wealth will become richer, while those with little or no wealth will remain poorer. This creates wealth inequality.

Answer 50

The Human Development Index (HDI)

Answer 51

Education: calculated using the average years of schooling for those aged 25 and the expected years of schooling for children who are about to start education. Health: life expectancy at birth Living standards: calculated using real GNI per person. And this GNI per person is adjusted for PPP. HDI is calculated as an index, with values between zero and one. Countries are ranked according to this index, with values closer to one depicting more development and values closer to zero depicting less development.

Answer 52

Advantages: Not reliant on any one measure. It is multidimensional. Uses two measures for education. Easy to calculate Disadvantages: Using averages means that it ignores inequality. Certain factors are missing, e.g. happiness, gender equality, ecological footprint.

Answer 53

Inequality-adjusted HDI (IDHI) Head count ratio Lorenz curve and Gini coefficient Multidimensional poverty Access to clean water Mobile phone owners

Answer 54

1. Primary product dependency 2. Volatility in commodity prices 3. Level of savings and investment 4. Foreign currency gap 5. Capital flight 6. Demographic factors 7. Access to credit and banking 8. Infrastructure 9. Education 10. Property rights

Answer 55

Measured by primary exports as % of GDP / % of employment Primary products are normally described as raw materials or agricultural produce. They are typically low-valued. This means that countries dependent on primary products tend to remain poor, as they get very low prices for them. Countries may increase the volume of trade by exporting more primary products but the value of exports will remain small (no value added - Western countries manufacture) Demand for primary products is income inelastic, which means that an increase in income brings about a much smaller change in the demand for these goods. This implies that world demand for primary products will not rise with rising incomes. Furthermore, if a country relies on its exports of primary products, while all its imports are high-value manufactured goods, it will experience falling terms of trade. This is known as the Prebisch-Singer hypothesis. Such countries will be unable to finance their imports through their exports. And so they may take loans from other countries. This hinders a country’s growth, as the government has to continually spend on debt repayment.

Answer 56

Commodities tend to have inelastic demand and supply. This causes price instability. This means that countries reliant on the production of commodities may face economic instability, high inflation, etc. This uncertainty is likelyto discourage FDI + difficult to plan and carry out investment (govt and private) in LR. Producer incomes can fall rapidly --> poverty.

Answer 57

Harrod–Domar model suggests that the main factors that affect growth and development are a country’s savings level and the capital-output ratio (i.e. the rate at which capital goods produce output). The savings gap is the difference between the actual level of savings and the level needed to achieve economic growth. Developing countries tend to have low levels of savings due to increased poverty rates. The Harrod–Domar model posits that low levels of savings mean that the country cannot invest heavily in capital. Capital is essential for rapid growth, as it improves productivity and efficiency. As a result, economic growth will be low. However, some developing countries do not have a functioning financial system. This implies that any savings by households are not being deposited somewhere from where the money can be borrowed for investment. A country may be able to borrow money from abroad to invest in capital goods. However, this will increase national debt and repayment may become increasingly difficult. Economic growth is not development and investment could be wasted.

Answer 58

This is when a country becomes a significant commodity producer in a short amount of time, causing an increase in demand for the currency (to enable people to buy the goods) which pushes its value up. This increases export prices and leads to a reduction in competitiveness of the economy, causing a fall in ouput in other areas. This occurred for the non-oil sectors in Venezuela and Nigeria.

Answer 59

This is about a country facing a shortage of foreign currency. This is usually the case with developing countries. There may be a shortage due to a number of reasons: Export earnings may be low. This may be because the country’s main exports are primary products, which are low-valued (+ probably high value inputs). An increase in world prices. Oil is a necessity everywhere. So if global oil prices increase, demand will fall by a negligible proportion. As a result, spending on oil imports will increase. Imports are bought using foreign currency. A country may have to use its foreign currency on debt repayment.

Answer 60

Capital flight will deprive a country of increased savings – and, therefore, investment. Low levels of investment slow down economic growth. Money that is saved abroad may be used to develop that country’s export industry. If recipient countries’ export industries become more competitive, it may further hamper the growth of countries experiencing capital flight. As a result, export earnings may decline and the current account deficit will widen. This contrasts the Harrod-Domar model which requires stability and investment to retain funds in a country.

Answer 61

Developing countries face a number of issues relating to their population. Firstly, developing countries tend to have large populations due to high birth rates. This increases the dependency ratio (i.e. number ofdependents on the working age population increases). A high dependency ratio means that one person’s income is spent on a number of people. This means income per person is low. Thus, savings will also tend to be low. Conversely, some countries face ageing populations. This, too, increases the dependency ratio. Also, the growth potential of a country tends to decline if it has an ageing population (as the working population is less).

Answer 62

Access to credit and banking is essential for entrepreneurs. Everyone needs cash to start their own business, particularly people who are geographically or occupationally immobile. In countries where such facilities are lacking, growth tends to be limited, as people find it hard to get out of poverty. However, microfinance is increasingly being used to overcome this issue.

Answer 63

Poor infrastructure makes trading very costly. Poor infrastructure discourages local investment and FDI.

Answer 64

Education is key to growth and development. Education enables potential workers to become more efficient and skilled in their field. Countries with high levels of education provide faster and sustainable growth.

Answer 65

Property rights provide certainty and confidence. If property rights are absent then it becomes hard to get a loan from banks because banks require collateral (usually property) in order to assess a person’s likelihood of repaying the loan.

Answer 66

Corruption and poor governance: Corrupt acts, such as bribery – and lack of accountability – lead to an inefficient resource allocation. Similarly, poor governance (which goes hand in hand with corruption) means that the ruling government is not running the country properly, which often creates law and order issues. This, too, leads to a misallocation of resources – because governments of many developing countries spend on goods and services that fetch votes during elections. They do not provide goods and services that are needed. - Wars Wars naturally hamper growth and development. Not only do wars put a halt to new development but also existing institutions and infrastructure are damaged. People cannot conduct business and children cannot attend schools. This has a long-term negative effect on growth. A sense of fear encourages people to flee the country. FDI does not come into the country, while existing multinational companies (MNCs) pull out.

Answer 67

Market-oriented strategies Interventionist strategies

Answer 68

1. Trade liberalisation 2. Promotion of FDI 3. Removal of government subsidies 4. Floating exchange rate systems 5. Microfinance schemes 6. Privatisation

Answer 69

This is about reducing trade barriers, such as tariffs and subsidies, to encourage free trade. Free trade is likely to promote growth. This is because employment opportunities will be created in industries that produce export goods and services. This will mean higher wages and tax revenue, which will result in great private and public spending. Also, increased choice for consumers in terms of cheap goods and services is likely to improve living standards. Free trade leads to greater efficiency in resource allocation, as countries only focus resources on the production of goods which it has comparative advantage in (recall theme 1). However, trade liberalisation can reduce the growth potential of a country, as the country may be flooded with cheap imports while its exports become uncompetitive.

Answer 70

FDI creates jobs in developing countries, which can help reduce poverty. More people will be earning an income, which will be spent in the economy. This will benefit firms and the economy at large. The government will be able to collect more taxes to spend on things such as education and health. However, China is notorious for taking its own workers abroad. FDI is a great way for developing countries to gain expertise and benefit from world-class equipment. FDI may be used to improve local infrastructure. Create jobs + multiplier effect (investment) Can fill the savings gap Repatriation of profits + exploitation of labour and environment FDI in India --> liberalised policies led to 48% increase in a range of sectors (manufacturing + railways).

Answer 71

Although subsidies are used to help certain firms or industries to grow, they do encourage inefficiency. Firms need to have competitiveness in order to survive. For this, they need to ensure lowest possible costs to keep prices low for consumers. In this manner, the most efficient firms survive and inefficient firms fall behind. This ensures that resources are allocated fairly and efficiently. Subsidies even allow inefficient firms to compete in the market and use up resources. And so removing subsidies opens up the once protected industries to global competition. Again, efficient firms will survive. And these firms also tend to charge low prices (as their costs are low), which will improve living standards because consumers’ disposable incomes will rise. However, since many firms are likely to shut down following such a move, unemployment will rise significantly. There will be additional costs for the government to provide benefits and training opportunities for these newly unemployed workers to find a job. Also, removing subsidies may reduce the international competitiveness of firms producing exports. So, exports will fall while imports will rise. This will worsen the current account deficit.

Answer 72

Switching from a fixed to a floating exchange rate regime will mean that the forces of demand and supply will decide the value of a country’s currency. Countries tend to peg their currency values at a high rate. And so switching to a floating system will cause their currency to depreciate. This means that its value compared to another currency will fall. In other words, one unit of the currency will now be able to buy fewer units of another currency. The benefit of this is that imports will become expensive, while exports will become cheaper. As a result, imports will fall and exports will rise. This will result in a current account surplus. Moreover, higher earnings from exports will translate into higher wages for workers – leading to greater tax revenues and private spending. However - volatilty -- difficult to make LR decisions

Answer 73

Microfinance refers to providing small loans (microcredit) to poor people. Banks or creditors (people/institutions who lend money) require borrowers to provide collateral (i.e. any personal asset that is kept with the bank in case the borrower is unable to repay his loan). Poor people do not tend to have any assets. Thus, they are always deprived of this facility, which is of paramount importance for entrepreneurship. Microfinance schemes have a mechanism in place to reduce the element of risk when lending to poor people with zero collateral. The way the scheme works is that small loans are given out to groups of people (typically women) – not individuals. The second person in the group will only get the loan once the first person has repaid his loan (using profit from their small home-grown business). This gives all the group members a stake in each other’s success. This means they help each other out and ensure that the loan is repaid. In South Africa - method of financing consumption -- most do not have funds necessary to ensure repayments. When microfinance is used for investment, usually used in informal economy with very little spent on sustainable methods of development.

Answer 74

Privatisation is about selling state-owned businesses to the private sector. It is argued that the private sector is more efficient than the public sector. This is because the main motive of the former is profit maximisation. In order to maximise profits, firms are encouraged to reduce costs. This suggests that resources are used efficiently to keep costs to a minimum. Also, profit-maximising firms have the capacity to increase workers’ wages. This increases people’s disposable incomes. Tax revenue will also rise, which will mean greater public spending. Can end corruption Ghana water industry privatised in 2011 - water quality improved

Answer 75

1. Development of human capital 2. Protectionsim 3. Managed exchange rate 4. Infrastructure development 5. Promoting joint ventures with global companies 6. Buffer stock schemes

Answer 76

Human capital can be developed by investing in education (and other training facilities that provide workers with current skills). Improving human capital will improve a country’s productivity, i.e. the same workers will now be able to produce more goods and services. Moreover, this reduces the average cost of production. This will make domestic goods competitive internationally. As a result, demand for exports will rise. However, improving human capital is a long-term solution for growth and development. Also, some may argue that it would better to invest in physical capital (technology), as it is free from any human error and would always be more productive than workers.

Answer 77

This is about enforcing trade barriers, such as tariffs and quotas. Doing so will protect local industries from foreign competition. And so local industries will get a chance to mature and become profitable. Once this happens, they can easily compete globally. (Policy of import subsitituion - deliberately attmept to replace improted goods with domestically produced goods by adopting protectionist measures). As a result, local employment will also be protected – which helps an economy to grow. However, this always keeps the country at risk of facing retaliatory policies. Moreover, this will lead to an inefficient allocation of resources. Countries lose out on benefits of specialistation and comparative advantage.

Answer 78

This is about allowing the forces of demand and supply to dictate the exchange rate – but it gives government room for slight intervention. This intervention is not very coercive: it is more indirect in its approach. For example, a government can change interest rates, which in turn would affect the exchange rate. For example, decreasing the interest rate means that consumers would prefer saving abroad, where the reward for saving is much higher (i.e. higher interest rate). This will reduce the demand for the domestic currency, thereby lowering its value. This is good for the economy as it will make domestic exports more attractive (as they will appear cheaper). As a result, exports rise and imports fall, which will reduce a country’s trade deficit. Black markets in foreign exhcnage can destabilise system Corruption - govt offocials make currency on stock exchange

Answer 79

Good infrastructure is essential for development. It reduces the costs of firms, as well as time lags. It will encourage potential firms to start their business, as good infrastructure might make running a new business (with its high sunk costs) more viable. Similarly, means of communication and information are also very useful for development. Good Internet connection makes it easier to connect to the world and market one’s business internationally for an international market. Free rider probelm - provided by government - positive social benefits

Answer 80

Joint ventures with global companies will equip domestic firms with greater expertise and knowledge. Domestic firms may be able to benefit from the advanced marketing of foreign firms. This will provide great job opportunities domestically, which will increase consumer spending – leading to more growth. Reduces expolitation from TNCs and FDI

Answer 81

As mentioned before, commodities face great variation in prices (price volatility) – due to reasons such as natural disasters and inelastic demand and supply. This means farmers’ incomes are under threat. Also, it makes it hard for them to plan ahead due to this uncertainty. This can be particularly harmful for countries that rely heavily on agriculture. Thus, some governments introduce buffer stock schemes to control this price volatility and with it farmers’ incomes and living standards. Buffer stock schemes set a price range within which the price of commodities is allowed to fluctuate. Beyond these limits, the government intervenes. The upper price limit is known as a price ceiling, while the lower limit is known as a price floor. However - storing persihable items is difficult and expensive Uncessary transportaiton costs and strogag costs Hard to inciorporate all the producers of commodities Inefficient suppliers produce extra as they know stock will always will be bought. Buffer stocks may not be large enough. Other countries may benefit since it keeps global prices fairly low and stable - free riders

Answer 82

1. Industrialisation 2. Development of tourism 3. Development of primary industries 4. Fairtrade schemes 5. Aid 6. Debt relief

Answer 83

The Lewis model (savings and investment key to growth) suggests that there are two sectors in the economy: agriculturalsector and industrial sector. The agricultural sector is largely rural, while the industrial sector is urban, as well as modern. The model suggests that workers from the agricultural sector (in developing countries) will migrate to the industrial sector, as they will be attracted by higher wages. The industrial sector will start making profits, which will be reinvested in the businesses. This will also raise wages and attract more workers from the agricultural sector. And eventually the economy will become fully industrialised. However, this model makes a number of assumptions which may not be the case. For example, it assumes that all profits will be reinvested. Also, it assumes that the industrial sector is labour-intensive (i.e. relies on human capital), whereas it may be capital-intensive. In which case, jobs will not be created in the industrial sector and workers will need to continue working in the low-paid agricultural sector. Higher wages - higher savings - fills savings gap

Answer 84

Developing countries can develop by promoting their tourism industry – given high incomes in developed countries. This can be done through an improvement in infrastructure, increased marketing, improvement in facilities for tourists, etc. It is useful to develop the tourism industry, as it is labour-intensive – and so job creation is guaranteed. Moreover, demand for domestic currency rises. This means that countries get the opportunity to earn foreign currency (fill foreign currency gap - but tourists usually like their own countries goods on holiday - host imports to cater does not fill currency gap Tax revenues increase However, tourism can bring many problems as well. Tourists can disregard the local culture: they pollute the environment -- externalities Seasonal, low-skilled, low-payed jobs (limits multiplier). TNCs repatriate profits

Answer 85

Countries that are rich in resources should focus on developing their primary industries. This should particularly be the case if a country has a comparative advantage in the production of primary products . This will increase world trade and ensure an efficient allocation of resources. Certain primary products are high-valued. For example, oil in the Middle East has allowed those countries to develop rapidly. Funds need to bused to diversify economy (Norway) Corruption and primary product dependency (eval)

Answer 86

Often developed countries have monopsony power (recall theme 3) (i.e. they, as suppliers, have the power to dictate what prices they pay developing countries for their primary goods). This means that developing countries get an unfair price for the export of their primary products. Therefore, Fairtrade schemes ensure that farmers in the developing countries get a fair price for their produce. Improved production standards - higher quality Guarantees a higher price Better working conditions, local sustainability (no child labour or environmental degradation). However, there is a need for several middlemen to be involved in the process for the scheme to work. But this reduces the amount that farmers get. Moreover, some suggest that supermarkets in the developed countries gain the most from Fairtrade – and not the farmers in the developing countries. Reduces inventive to diversify and instead stay in low-profit activities (However, funds to send children to school can lift family out of poverty) Doesn't address the fundamental cause of poverty Excess production (incentive of higher price - expansion of supply lowers world price) Could leave non-fairtrade producers worse (fall in demand)

Answer 87

Aid can be used to further development. Aid comes in various categories: Humanitarian aid: this is financial or food aid given during times of crises (wars, natural disasters). Grants: financial aid that is not a loan (i.e. it does not need to be repaid). Loans: money that needs to be paid back with interest repayments. Reduces absolute poverty and call fill the savings gap (infrastructure or human capital). However, aid can make countries dependent on it. Once aid is withdrawn, countries do not adopt other means of development. Aid that comes in the form of loans needs to be repaid and increases countries’ debts. This means that tax revenues are eventually used in debt repayment rather than on things such as health or education. Often aid comes as ‘tied aid’. This means that donor countries provide aid conditional on recipient countries fulfilling certain agreed conditions; for example, the USA lends money to some countries conditional on those countries buying American weapons from that aid money. Corruption and economic reliance.

Answer 88

During the 1980s and 1990s, several developing countries suffered from a ‘debt crisis’ – i.e. debts had increased to such high levels (coupled with rising interest rates and the dollar exchange rate) that they became unable to repay their loans (defaulting on loans). Following these defaults, these countries were unable to take further loans. And this had knock-on effects on the growth of these countries. This is because loans needed to be taken to invest in capital, infrastructure, etc. Eases govt finances - infrastructure + provision of services + less interest repayments Hence, debt relief was brought about, which reduced the amount of loan repayments for many countries. However, loans were given out conditional on countries meeting certain criteria (free market reforms). Free market reforms are all those measures that allow markets to operate freely without any intervention. These measures include trade liberalisation, privatisation and decreased regulation. But this also had negative effects on many countries. For example, Haiti was asked to remove its trade barriers – and the once self-sufficient country in the production of rice became heavily dependent on cheap American imports. Moral hazard - every poor country expects debt relief - eases pressure on weak governments to adopt reforms and good economic policies.

Answer 89

World Bank: this is a global institution that gives out long-term grants/loans to developing countries. These grants (or loans) range from humanitarian aid to developmental aid. For example, the World Bank partially funded the Narmada dam in India – which was a long-term project. Strengthens private sector in developing countries by providing financial, technical assistance and settling disputes.

Answer 90

International Monetary Fund (IMF): This is a global financial institution which gives out short-term grants/loans to countries. These loans are needed to maintain stability, improve trade deficits, prevent economic crises, etc. IMF received criticisms for creating problems in countries - usually, loans involve reducing imports, increasing exports and lowering govt spending -- the lower standard of living.

Answer 91

Facilitate savings Lend to businesses/individuals Facilitate the exchange of goods and services (e.g. payment systems) Forward markets Market for equities

Answer 92

1. Asymmetric information 2. Externalities 3. Moral Hazard 4. Speculation 5. Market Rigging

Answer 93

This occurs when one party knows more than the other. In this case, it would mean that perhaps borrowers know more than the lenders. This is because people borrowing money would know whether they are able to repay the loan – not the lenders/sell them products they don't need. Similarly regulators know less than the banks about the latter’s policies, etc. As a result, genuine borrowers may be undermined due to the issue of asymmetric information. And if borrowers who are not credit worthy are given loans (adverse selection), this will affect the entire economy. This can be seen from the global financial crisis of 2007/8. Also between financial institutions and regulators.

Answer 94

Risky behaviour in the financial market can have serious negative externalities (or costs). For example, the 2008 recession not only affected the lenders and borrowers involved but affected the whole economy. Other taxpayers had to finance the losses; workers in other sectors faced pay cuts; unemployment rose; incomes fell; and the growth rate slumped. Also long-term economic damage.

Answer 95

Moral hazard refers to a situation where one person’s actions negatively affect someone else – and not the person themselves / individuals leverage firms to increase their salary. For example, following the 2008 recession, banks (who were mainly responsible for the collapse) were bailed out at the taxpayers’ expense. Therefore, this would have made banks feel more confident in carrying on with their risky behaviour – because someone else gets penalised. Central bank as lender of last resort.

Answer 96

Poor lending decisions by bankers can lead to the creation of what we call a ‘market bubble’. This basically refers to an artificial (and, so, unsustainable) rise in the value of an asset, e.g. house prices – which is caused by inflated expectation about the rise in the value of the asset (speculation). When this happens everyone (herding behaviour) rushes to buy the asset to gain from the rising value. Banks provide the funds needed to purchase the assets. However, at times, banks would lend to borrowers who are unable to pay back the loan. This becomes a cause of concern when speculators feel that the value of an asset will rise no more. This is because asset owners will try to sell their assets in haste. This will cause a sudden and significant fall in the value of the assets. This will lead to a negative wealth effect (i.e. asset owners will feel less well-off due to the fall in their wealth). This will mean aggregate demand will fall, leading to reduced consumer spending and its positive effects on the economy. This is what led to the 2008 global financial crisis. However, another aspect which led to the crisis was that banks packaged these ‘bad loans’ (because the borrowers were unable to pay them back) with other loans and sold them to other banks. Once the bubble had burst, banks realised that these packages had much less worth than was considered. This had a negative effect on the general confidence level in the country. As a result, inter-bank lending (banks lending to each other) stopped, while loans became harder to get.

Answer 97

Market rigging is an illegal practice, as it involves artificial manipulation of something for personal gain. In this context, it usually takes place in banks when setting interest rates and exchange rates. Market rigging can only take place when banks can get confidential information about their borrowers that will affect the exchange rate. Once they are certain about their client activity, they will place their orders (informed decision) to profit from the consequent changes in the exchange rate.

Answer 98

1. Implementation of monetary policy Central banks are in charge of the monetary policy (recall theme 2). Monetary policy is about changing the money supply and/or the interest rate primarily to affect inflation rates, which in turn affects the whole economy. 2. Banker to the government Central banks act like commercial banks for the government only. Various government departments need an account from which to withdraw money. 3. Banker to other banks When commercial banks run out of cash (liquidity crisis), the central bank acts as the ‘lender of last resort’. This means that it lends money to these commercial banks to help them. It is very important for the central bank to help the commercial banks, as they form the backbone of the economy. Lending money is essential for business growth, which creates jobs and provides income to be spent in the economy. 4. Regulation of the banking industry Central banks may regulate the commercial banks. For example, many central banks require commercial banks to maintain reserves. This means that not all money that is saved should be given out in loans: banks must retain a certain amount of this money. This is to help banks avert a liquidity crisis.

Answer 99

Capital expenditure is needed for the country to grow. It increases a country’s productive potential and causes its production possibility frontier (PPF) to shift out (recall theme 1). It involves spending on infrastructure, education, healthcare, etc. Investment in these will improve the skill level and the health of the economy; it will reduce firms’ cost of production.

Answer 100

Current expenditure is required for the day-to-day running of the public sector. It involves spending on wages of public sector workers, utility bills, equipment and other items (e.g. NHS drugs).

Answer 101

Transfer payments are needed to distribute income within the country – and, thereby, reduce absolute poverty and income inequality. This includes spending on child benefits and jobseeker’s allowance. This aims to create an equal society.

Answer 102

1. Changes in income 2. Changes in demographics 3. Changes in expectations 4. Financial crises

Answer 103

As incomes rise, fewer people rely on state-funded services and more opt for private services instead, e.g. switching to private health care from the NHS. Similarly, as incomes rise fewer people need safety nets. As a result, government spending will fall as incomes rise and vice versa. However, in HICs, some demand more from the government (if income elastic). And if low incomes - low tax revenues - low base for welfare spending anyways

Answer 104

Changes in demographics: Different countries will have different distributions of age. For example, in the UK the proportion of elderly people is rising (ageing population). This means that the government has to spend more on healthcare and other facilities needed by the elderly. Likewise, countries with a younger population will spend more on child benefits, etc.

Answer 105

A government may expect there to be a ‘baby boom’ in the coming years and would increase its spending on healthcare and education. Also, if consumers want more to be spent on benefits than on education subsidies, the government may oblige consumers’ wants.

Answer 106

During a financial crisis, the government is likely to increase spending to provide jobs following an increase in unemployment levels. During the 2008 recession, the government had to spend heavily to bail out banks.

Answer 107

1. Productivity and growth 2. Living standards 3. Crowding out 4. Level of taxation 5. Equality

Answer 108

High public expenditure can increase growth if it creates more jobs. This is because more jobs will mean greater consumer spending in the economy, which increases growth. Also, high capital expenditure will increase productivity and growth, as investing in human capital or physical capital increases efficiency levels - R&D, education + skills Multiplier effect Conversely, if current spending is high, it will contribute little to productivity and growth. Similarly, high transfer payments will not increase the growth rate. Free market economists believe govt spending is wasteful and inefficient.

Answer 109

Transfer payments, in particular, improve living standards. However, they only ensure that nobody falls into absolute poverty. They do not improve the living standards of people who are not on benefits. Capital spending is likely to improve living standards through increased growth – but only in the long term. Govt can correct market failure and provide public goods. If inefficient, SoL can fall

Answer 110

If public spending increases significantly, it will reduce the size of the private sector. Financial crowding out takes place when the government funds its spending through increased borrowing. This increases the interest rate, which discourages investment in the private sector – because the cost of borrowing increases. As a result, the private sector will shrink in size. Since resources are scarce, an expansion of the public sector can only come from resources (and borrowing) that are taken from the private sector. This causes a resource shortage in the private sector, which reduces the private sector. Full effect at full employment - if there is high unemployment then extra government spending can encourage crowding in through extra investment.

Answer 111

In most cases, where government spending is high, levels of tax must be high in order for spending to be sustainable. High levels of tax may have a disincentive effect. Oil-rich countries tend to be an exception, where revenue from oil can pay for most of government spending.

Answer 112

Greater capital spending will initially increase inequality as it may be increased at the expense of transfer payments. But, thereafter, it will increase incomes and living standards for all. However, if spending on transfer payments is increased, this will increase equality in the society. This is because transfer payments are about taking money from the rich (taxpayers) and giving it to the poor.

Answer 113

Progressive taxes are used to increase equality in the country. This is because low-income earners give a small proportion of their income in taxes, while high-income earners give a high proportion of their income in taxes. For example, where those earning £10,000 pay 10% in taxes but those earning £30,000 pay 20% in taxes.

Answer 114

Proportional taxes mean that every person gives the same percentage of his/her income in taxes. For example, if the tax rate is set at 20%, then those earning £10,000 and those earning £60,000 will both give 20% of their income in taxes.

Answer 115

Regressive taxes seem to reward high-income earners. This is because low- income earners pay a greater proportion of their income in taxes, while high- income earners pay a smaller proportion of their income in taxes. Britain has some of the highest rates of fuel tax. This is an example of taxation that would adversely affect low-income earners. This is because most people in Britain own a car – so fuel, in a sense, is a necessity today. Therefore, a high fuel tax will consume a greater proportion of a low-income earner’s tax than a high-income earner’s.

Answer 116

1. Incentive to work 2. Tax revenues 3. Income distribution 4. Real output and unemployment 5. Price level 6. Trade balance 7. FDI flows

Answer 117

High tax rates (or progressive taxation) may discourage workers from working harder. They will refrain from working long hours or improving their productivity. This will have negative effects on the whole economy. Free market economists belive supply of labour is relatively elastic In some cases, this may create tax exiles, who move to another country with lower taxes. Again, this affects the domestic economy. Nordic countries - high income taxes - similar rates of growth compared to UK/US Higher taxes may mean people work longer to maintain their incomes

Answer 118

The Laffer curve suggests that initially as the tax rate is increased, more tax revenue is gained. However, after a point any further increase in the tax rate causes a fall in tax revenue (see Figure 6). This may be due to an increase in tax avoidance and tax evasion (i.e. people will try to pay less taxes than they are supposed to pay, either legally or illegally). This may also be because of tax exiles – this will reduce the number of people paying taxes in the country. And so naturally tax revenues will be low.

Answer 119

Progressive tax regimes help redistribute income, as they take a greater proportion of income from high-income earners. Also it may be that tax revenues are mainly used to help those on low incomes, e.g. through the provision of benefits or training facilities to improve the skill level of low-skilled workers. Regressive taxes, however, increase income inequality, as they have a greater impact on low-income earners.

Answer 120

Taxes tend to reduce real output. This is because taxes reduce consumers’ disposable incomes. This means less money is left to spend in the economy. And so aggregate demand falls (taxes are a leakage from the circular flow of income). A reduction in real output will automatically increase unemployment. Remember, demand for labour is derived demand, i.e. when demand for goods and services falls so does the demand for labour. Taxes may also directly have an impact on employment. Workers may feel discouraged to enter the job market, and so may choose to rely on benefits or other means of income.

Answer 121

Price level refers to the inflation level. Direct taxes may have a deflationary effect on prices. In other words, price level may fall following a rise in direct taxes. This is because direct taxes tend to reduce aggregate demand and consumer spending. As demand falls, prices also fall. However, indirect taxes have an inflationary effect on prices (cost-push inflation). Indirect taxes are taxes on goods and services – and so, naturally, it increases the prices of goods and services in the economy. This increase in prices will force workers to demand higher wages, in order to keep up with inflation and maintain their living standards. However, if this happens, the cost of production for firms will rise – which will lead to a further rise in prices.

Answer 122

An increase in direct taxes reduces consumers’ disposable income. This leads to a fall in aggregate demand within the country. Similarly, demand for imports falls because consumers have less income to spend. A reduction in imports will reduce the current account deficit (assuming exports remain the same or increase). Therefore, direct taxes will improve the balance of trade. However, in the LR, AD will fall (accelerator effect) - less investment - less competitiveness so lower exports.

Answer 123

High tax rates will discourage foreign direct investment (FDI) from coming into a country. This is because the firms’ own profits will be taxed heavily and also, with high income tax rates, consumer spending will be low, which reduces the profits of those firms. Conversely, if tax rates are low compared to other countries, then FDI flows will increase – which will have many positive effects on the domestic economy, such as job creation, improvement in infrastructure and exposure to new skills and technology. 'Race to the bottom' - lower taxes to attract FDI

Answer 124

Throughout the economic cycle, government spending and taxation automatically adjust to changes in the economy. For example, during a recession, since consumer spending falls and unemployment rises, government spending will increase to provide additional benefits while taxes will decrease to encourage spending. Likewise, during a boom when consumer spending is high and unemployment is low, government spending will fall due to a decline in the need for benefits. Taxes, on the other hand, will rise to benefit from high tax revenues and also to control inflation (taxes reduce disposable income, which reduces consumer spending and this keeps the price level under control). This automatic adjustment of government spending and taxation refers to automatic stabilisers. Discretionary fiscal policy is a policy measure that a government takes to achieve a particular goal (deliberate manipulation of G) It is not a reactive response to a change in any economic variable but a calculated approach.

Answer 125

Fiscal deficit is calculated annually to see how the budget panned out by the end of the year. National debt is the cumulative of all the fiscal deficits. In other words, it is a measure of all the outstanding loans that a country has ever received.

Answer 126

Cyclical deficits are deficits that come and go with changes to the economic cycle. So during a recession, the fiscal deficit may be high, as fewer taxes are collected (due to high unemployment) and government spending is raised. While, there may be a fiscal surplus during times of booms. Thus, deficits rise and fall with the growth of an economy. Structural deficit is permanent. It remains even when the economy is producing at its maximum capacity - not linked to the state of the economy. If there are persistent structural deficits then the national debt will grow overtime - difficult to know what is cyclical ad what is structural

Answer 127

1. The state of the economy 2. The housing market 3. Politics 4. Unplanned events

Answer 128

If the economy is performing well then the fiscal deficit is likely to be low (or there may even be a surplus). This is because unemployment will be low, which would mean increased tax revenues and low government spending in terms of benefit payments. Basically, money coming in would exceed money going out. Conversely, during a recession, the fiscal deficits tend to increase. This is because unemployment is high, which means fewer taxes are collected and at the same time spending on social security is increased.

Answer 129

The housing market is very important to any economy because houses are extremely valuable assets that are also treated like a necessity (i.e. everybody needs them). Government levies taxes on the sale of houses: this is known as stamp duty. Thus the higher the house price, the more tax revenue is earned. Therefore, when house prices are rising, deficits can shrink because tax revenue may exceed government spending – and vice versa.

Answer 130

Different political parties may have different priorities. So some parties focus on contractionary fiscal policy (i.e. increasing taxes and reducing spending): this reduces the fiscal deficit. Other parties may focus on expansionary fiscal policy (i.e. increasing spending and reducing taxes): this increases the fiscal deficit. Austerity reduced the fiscal deficit by 75% since 2010

Answer 131

These are major incidents that occur suddenly and have a massive impact on government spending. Suppose there is a sudden outbreak of a disease in the UK. This will require an immediate increase in spending on the NHS. And, consequently, this will increase the fiscal deficit.

Answer 132

The number of dependents - if high then the deficit is usually high One-off events - e.g. privatisation Interest rates (repayments)

Answer 133

National debt is affected by the size of the fiscal deficit (and what factors affect the fiscal deficit as discussed above). National debt increases as the fiscal deficits over the years increase. This is because there is more need to borrow money to finance any spending that cannot be covered through tax revenues. Conversely, if a government decides to raise taxes and cut government spending for a number of years, then national debt is likely to decrease.

Answer 134

1. Interest rates 2. Debt servicing 3. Intergenerational equity 4. Inflation rates 5. Credit rating 6. FDI

Answer 135

If a country has a high level of national debt, then the interest rate on any further loans is likely to be very high. This is because creditors take into account the high likelihood of such countries defaulting on their loans. So in the meantime high interest rate repayments may provide some compensation (should borrowers default on their loans). Could cause crowding out

Answer 136

If a country has a high level of national debt, then a greater percentage of the GDP will have to be spent on debt repayment. Size of the impact depends on the level of interest rates and the size of the primary deficit compared to interest repayments.

Answer 137

Intergenerational equity refers to the effects of actions taken by the current generation on the next generations. So, for example, it would refer to how high levels of borrowing today (to improve current living standards, perhaps) will mean that the next generation will have to use their taxes to repay those loans, instead of spending it on themselves. So in this case, there is a lack of intergenerational equity – as the next generation will be treated unfairly and would be worse off than the current generation. So high levels of debt reduce intergenerational equity. Is the deficit caused by current or capital expenditure - Govt should run a current budget surplus to enable to invest for future

Answer 138

If the government raises taxes and reduces spending to decrease its fiscal deficits, then this is likely to lower inflation. This is because high taxes reduce consumers’ disposable income, which leads to less consumer spending (this reduces aggregate demand and growth). Spending cuts increase unemployment, as many workers are made redundant – and this, too, reduces aggregate demand. Thus, both measures will push prices down. However, if the government increases the money supply to repay some of its debts, this will increase inflation. A government can sell bonds to commercial banks or individuals to pay back some of its loans.

Answer 139

Increased deficits or national debts reduce the chances of a government repaying all its loans. This is due to a number of reasons:  Such a large debt cannot be repaid over time. It will take time to repay the loans, which may go beyond the time limit set.  Governments would have to bring in austerity measures to reduce the fiscal deficit – and, therefore, overall debt levels. This is not a very popular option with politicians, as all economic actors (consumers, businesses, etc.) are worse off as a result of it – and it could affect election outcomes.  It may be that more loans are taken to repay previous ones, which means that the national debt levels remain unchanged. Therefore, as the ability of a state to repay its loans becomes questionable as national debts rise, its credit rating falls. This means that such countries are, in a way, labelled as being incapable of repaying loans. And, as a result, other countries and/or institutions become reluctant to give out any more loans to countries with a poor credit rating.

Answer 140

High levels of debt are also likely to reduce FDI inflows because foreign-owned businesses prefer operating in countries that are politically and economically stable. The reason for this is that they can predict government policies and consumer behaviour. Whereas an unstable economic environment creates more uncertainty. For example, creditors may suddenly decide to stop lending to countries with huge debts (due to their inconsistency in loan repayment). This is likely to have negative effects on a country’s development – for example, investment on infrastructure may decline rapidly. This affects firms’ profitability by raising their cost of production.

Answer 141

A deflationary fiscal policy (high taxes and reduced spending). Spending cuts reduce the need for borrowing money, as any spending can be financed through tax revenue. However, this does lead to lower growth rates because unemployment rises (from spending cuts) and consumers’ disposable income falls (from high taxes). As a result, consumer spending and, thus, aggregate demand fall. Also, spending cuts on merit goods (goods that are beneficial for us), such as education and healthcare, cause living standards to decline. Free market economists argue spending can be reduced by cutting waste instead (difficult to do so) Automatic stabilisers (US post-2008) Or high spending (e.g. expansionary monetary policy) - high spending so high tax revenues.

Answer 142

Progressive tax system Redistribution of income Transfer payments (universal/means tested benefits) Provide universal goods and services (education and healthcare) Reduce wage differentials (NMW, Equal pay legislation, Trade Unions, Education and opportunities) The law of diminishing marginal utility suggests that redistribution increases total utility and therefore is a better allocation of resources. The higher the spending of an individual, the less satisfaction they gained from spending an extra pound. £10 a week given to a poor family increases satisfaction more than £10 given to a rich family would. The high growth rates of Nordic countries, like Denmark, where redistribution is high suggests that it is not negative for economic growth.

Answer 143

Exchange rate policies (China) Trade agreements Improving access to and the quality of education - productivity and skills. Lower income tax can attract the unemployed to join the labour market.

Answer 144

Monetary policy - interest rates and QE. Reducing the money supply lowers inflation.

Answer 145

Commodity price shock. Therefore, a rise in the price of oil leads to inflation (cost-push inflation). Individual governments may not be able to impose deflationary policies, such as raising taxes, with success because higher taxes are unlikely to bring the prices of the goods in question down (as they are essential items) – only luxury goods will face falling consumption. Financial crises, such as the 2008 global financial crisis, have major effects on world economies. The 2008 crisis began in the USA but, due to ever increasing globalisation, quickly spread to other parts of the world. No individual country can prevent itself from the crisis. Since global banking networks, the market for labour, goods, etc. are so interdependent, it is difficult to stop any financial crisis from having a domino effect on all countries.

Answer 146

Governments can make it mandatory for all transnational companies to use local factor inputs, e.g. labour or raw materials. This would ensure that unemployment falls and standards of living rise, with more incomes. This will ensure a steady flow towards tax revenue, as well – which the government can spend to improve provision of public goods (healthcare, education, etc.) and create more jobs. Likewise, the government could make it mandatory for transnational firms to export a certain percentage of their products. This will help improve a country’s current account imbalance, while providing extra income from exports. - A major concern for most countries is the use of transfer pricing. This allows firms to lower their profits in countries where corporate tax rates (tax on profits) are very high, to benefit from paying fewer taxes. Less-powerful nations may find it particularly hard to tackle this issue. HMRC challenges TNCs that don't allocate sufficient profits OECD introduced Transfer Pricing Guidelines in 1995

Answer 147

It is particularly hard to regulate transnational companies, as they are mostly ‘footloose’ (i.e. they can easily move from one country to another). So if a government tries to regulate a firm, it may just relocate to another country – and this will deprive a country of any benefits that the firm may be providing its economy with.

Answer 148

Inaccurate information: old or inaccurate data on GDP, employment, inflation, etc. make it hard to come up with effective policies. For example, without accurate data, the central bank would not know the rate at which interest should be set. Risks and uncertainties: policymakers always face the risk of not knowing the actual result of their policies. Well-meaning policies may not necessarily have the desired effect. This is because it is hard to predict human behaviour. For example, a country may lower its interest rate to increase investment but businesses may not invest due to lack of political stability. This could make banks and savers worse off. Inability to control external shocks: globalisation has meant that an incident in one country may have an effect on another country. Thus, with interdependent markets, it becomes hard for individual countries to implement policies that will have the desired effect.

Economics Theme 4 Flashcards

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