ECONPLUSDAL THEME 2 Flashcards
1
Q
Macroeconomic Objectives
A
Balanced trade
Low and stable inflation
Strong and sustainable growth
Fair distribution of income
Full employment
Environmental sustainability
Sound government finances
Productivity growth
2
Q
Firms –> Households
A
Goods and services
Factor incomes
3
Q
Households –> Firms
A
Consumer expenditure
Factors of Production
4
Q
Leakages
A
Savings
Taxation
Imports
5
Q
Injections
A
Investment
Government spending
Exports
6
Q
National income
A
Measures the monetary value of the flow of output of goods and services produced in an economy over a period of time.
7
Q
GDP
A
Gross Domestic Product; refers to the value of goods and services made in a country
8
Q
Nominal vs Real GDP
A
Real values are adjusted for inflation, while nominal values are at current prices
9
Q
GDP Methods
A
Output Method (Goods & Services)
Income Method (Factor incomes)
Expenditure Method (Consumer expenditure)
10
Q
Advantages of Real GDP as a Comparison of Living Standards
A
FREQUENTLY - most countries provide information on GDP on a quarterly basis (which allows a user to spot trends more quickly)
WIDELY - some measure of GDP is available for practically every country in the world
CONSISTENTLY - measured consistently in that the technical definition of GDP is relatively consistent among countries
EASY - to calculate and interpret
11
Q
Disadvantages of Real GDP as a Comparison of Living Standards
A
INACCURATE DATA COLLECTION - Each method of estimating GDP is imprecise, leading to inaccuracies in the published figures
UNPAID WORK - Non-marketed outputs e.g. DIY, the value of housework and voluntary activities are not yet part of official national income figures
SUBSISTENCE - Farmers, for example, consume what they produce, and as these goods are not traded, they do not appear in national income statistics
SIZE OF PUBLIC SECTOR - If government spending is high, does this necessarily mean there has been greater output? Or could this be a result of inefficiencies?
THE BLACK MARKET - Undeclared economic activity e.g. goods that are paid for without being declared for tax reasons is excluded from official income figures
REMITTANCE - Not included in GDP; FDI included
12
Q
Limitations of GDP as a measure of standards of living
A
EXTERNALITIES (UNINTENDED CONSEQUENCES) - pollution and environmental degradation may vary
QUALITY OF LIFE
POPULATION SIZE AND AGE DISTRIBUTION - to take account of differences in population size it’s necessary to calculate GDP per capita. Difficult to account for differences in age distribution
INCOME DISTRIBUTION - measuring living standards through GDP per capita would only be accurate if the distribution of income were the same in every country
13
Q
Advantages of GNI as a measure of standards of living
A
Same as GDP
Includes remittance and removes FDI, thereby only including money kept in the country
14
Q
Green GDP as a measure of standards of living
A
Same as GDP
Accounts for environmental costs
…but very subjective
…causes figures to fall dramatically (too politically sensitive to use)
15
Q
Causes of short-term/actual economic growth
A
Increase in AD
Increase in SRAS
16
Q
Causes of long-term/potential economic growth
A
Increase in quantity and/or quality of factors of production
Increase in productivity
Technology improves
Discovery of natural resources
Supply-side policies (education, deregulation, investment)
17
Q
Boom
A
A period when the rate of growth of real GDP is fast and higher than its long-term trend
18
Q
Slowdown
A
A weakening of the rate of growth, real GDP is still rising but increasing at a slower rate
19
Q
Recession
A
2 consecutive quarters of negative growth
20
Q
Recovery
A
A phase of the cycle, after a recession or depression, during which real GDP starts to increase and unemployment begins to fall
21
Q
Depression
A
A prolonged downturn in the economy and where a nation’s GDP falls by at least 10 percent
22
Q
Potential Output
A
The Output that could be produced in the economy if there were a full employment of resources
23
Q
Output Gap
A
Measures the deviation between actual output and estimates of long-run potential output
24
Q
Negative Output Gap
A
When actual GDP is less than potential GDP. Some factor resources are under-utilized. Main problem is likely to be higher unemployment
25
Positive Output Gap
Actual GDP is greater than potential GDP. Some resources working beyond usual capacity (shift work & overtime). Main problem is rising inflationary pressures
26
Steps to find CPI
1) Family expenditure survey, sent to about 10,000 households, track spending for 2 weeks
2) 650 most popular goods and services are collected - make a 'basket'
3) Weights attached to goods based on their importance (% of income spent on them); weighted between 0 and 1 e.g. 50% [Symbol] 0.5
4) Base year selected - index of 100
5) Inflation tracked over period of time to give indexes for subsequent years (indexes calculated by (value of basket)/(value of basket in base year) * 100)
6) Data collected monthly to calculate inflation
7) 'Basket' of goods/services changed every year
27
Problems with CPI
Basket not representative of all consumers
Data may be inaccurate
Other countries may use different measures
Takes time for basket to change
If basket changes --> comparisons of past inflation becomes difficult
28
Demand Pull inflation
AD rises
Firms increase output to match
More pressure is put on factors of production, increasing their prices
29
Cost Push inflation
Firms respond to rising costs by increasing prices. CAUSES: Rising wages; Higher prices for raw materials; Exchange rates down; Business tax up (all factors that increase costs of production, making SRAS fall)
30
Consequences of inflation
Cuts value of cash in pocket
Hurts people on a fixed income - can't buy as much so living standards go down
Hurts saves if interest rate is less than inflation
Hurts poor more
Hurts more if your pay rise is less than inflation
Helps people who borrow a lot - if you owe £100,000, you can pay it back later when it's worth less
31
Deflationary spiral
When deflation occurs, the falling prices cause consumers to hold back consumption until prices fall even more, reducing overall economic activity. This idles productive capacity, so investment falls and AD drops further. This causes the deflationary spiral
Reduces the effect of interest rates (real rate always positive)
Increases the real value of debt
32
Unemployment
Those registered as able, available and willing to work, but who cannot find work despite an active search
33
Labour Force Survey
International Labour Organisation
Telephone Survey of 80,000 households = 100,000 people - must have actively sought work in the last 4 weeks and be available to start within 2 weeks. Over 16. Higher than Claimant Count. Currently 4.3% (42 year low).
34
Positives of LFS
More comprehensive
Includes all unemployed people
Internationally agreed standard
35
Negatives of LFS
Inconvenient (time consuming)
Sampling errors
People who want longer hours not included
36
Claimant count
The number of people who claim monthly JSA/Number of people who want to work. Must be out of work, capable of work, available for work, and actively seeking work. Not resigned in past 6 months or refused past 3 jobs. 18 to retirement age. Savings cap - 6k to 16k. Partner's income taken into account. Must attend fortnightly Jobsearch Reviews.
37
Positives of Claimant count
Data is free
Easy to calculate
Constant accumulation, so current
38
Negatives of Claimant count
Many women want work but can't get benefits (husband makes too much money for that etc.)
Older workers may be getting a pension from their old job or be supported by a spouse so can't get benefits
Women can't be registered as unemployed until they're out of work for a few weeks
Doesn't include part-timers
People might not be looking for a job but would take one if offered e.g. mothers raising a family
People moved from unemployment to sickness benefits aren't counted
Government can manipulate data
People can claim benefits sometimes even if employed
39
Unemployed not included in the measures
Economically inactive (Discouraged workers; Hidden unemployed)
Under-employed
40
Cyclical unemployment (demand-deficient)
Labour is a derived demand. If growth is low, demand for labour will be low, causing unemployment
41
Structural unemployment
Immobility of labour (occupational or geographical)
42
Frictional unemployment
When workers are between jobs (not bad)
43
Seasonal unemployment
Regular seasonal changes in employment/labour demand. Affects certain industries more than others - Catering/Leisure, Construction, Retail, Tourism, Agriculture etc.
44
Real-wage unemployment
Created when real wages are maintained above their market clearing level leading to an excess supply of labour at the prevailing wage rate. Some economists believe that unemployment can be created in the national minimum wage is too high
45
Negative Consequences of Unemployment (Private)
Social exclusion
Can't buy as many luxuries [Symbol] Living standards drop
Depression/anxiety
Move to public school
Potential divorce
Increased health risk
Loss of marketable skills + motivation
Less likely to get a job (they think the fact that you were unemployed for a while suggests there's an issue)
46
Positive Consequences of Unemployment (Private)
Get more education
More time with the kids (leisure time)
Can make a career change
Redundancy pay
47
Negative Consequences of Unemployment (Businesses)
Less workers = Output down
Less demand for product
Less demand for businesses further down the supply chain
Negative multiplier effects from the closure of a major employer in a region
48
Positive Consequences of Unemployment (Businesses)
Wages decrease
More available workers, so more good workers
People are more scared of job losses, so less likely to strike
49
Negative Consequences of Unemployment (Government)
Tax revenue down (Income, VAT, Corporation)
Spending up (Benefits)
More borrowing
GDP falls in the short term
Inefficient allocation of resources - inside PPF curve
Some people might leave the labour force permanently
50
Positive Consequences of Unemployment (Government)
Inflation down
Imports down, so (X-M) up
51
Negative Consequences of Unemployment (Society)
Higher crime
Areas become run down
Increased depression
52
Current Account
Trade balance:
Trade in goods
Trade in services
Investment income from abroad
Current Transfers between governments and countries
53
Investment income (BoP)
This includes profit, remittances, dividends and interest receipts from abroad minus profit, dividends and interest paid abroad. Investment income is earned on loans, and portfolio and direct investment
54
Current transfers (BoP)
Includes:
Government payments to the EU
Government spending on embassies and armed forces commitments; International aid payments from the UK to other countries
Private transfers between households
55
Causes of Trade Deficit (demand side)
Strong domestic growth (High demand for imports)
Recession overseas (low demand for exports)
Strong exchange rate (SPICED)
56
Causes of Trade Deficit (supply side)
Low investment (Exports less competitive)
Low productivity (exports less competitive)
High relative inflation (exports less competitive)
High ULC (exports less competitive)
Poor quality/reliability (exports less competitive)
Depletion of resources (can export less e.g. North Sea Oil)
57
Consequences of a Trade Deficit
AD falls --> growth falls; unemployment rises
Worsens north-south divide
Imported inflation
...but higher standards of living
...better quality goods
...not very significant
...good if demand-side
58
Causes of a Trade Surplus in Goods
A low value of the pound making UK goods internationally competitive
A world boom causing an increase in demand for UK exports
A recession in the domestic economy causing a lower demand for imports
Improved quality, design, reliability and availability of UK goods
59
Consequences of a Trade Surplus
More internationally competitive
More confidence
More FDI
...but inflationary pressure
...stronger pound
...worsening living standards
60
Benefits of trade
Allows for specialisation (production of goods at low costs; import goods that can't be produced) - increases welfare
Access to larger markets for firms (sales and purchasing; profits rise)
Faster improvement of technology
Lower prices
Higher quality goods
Greater choice of goods
61
Costs of Trade
Contraction & expansion of industries - occupational immobility of labour (unstable)
Decline of industries
62
Exchange rate
The price of one currency in another currency. Determined by supply and demand
63
Causes of exchange rate changes (demand up
Higher relative interest rates (hot money flows)
Speculation (anticipate a rise in ER)
Increase in FDI
Rise in incomes abroad
Increase in competitiveness (ULC down, Inflation down, productivity up)
64
Causes of exchange rate changes (supply up)
Fall in interest rates (hot money flows)
Speculation (anticipate fall in ER)
Firms moving away from Britain
Increase in incomes domestically
65
SPICED
Strong Pound Imports Cheaper Exports Dearer
66
Impact of an exchange rate appreciation
(X-M) falls, AD falls --> Growth falls
Imports less expensive, causing costs of production to fall --> SRAS rises
67
Impact of an exchange rate depreciation
(X-M) rises, AD rises --> faster growth
Imports more expensive, causing costs of production to rise --> SRAS falls, cost-push inflation
68
Impacts of Exchange rates evaluation
Depends on:
PED for exports and imports (Marshall-Lerner)
Size of the appreciation/depreciation
Restrictions on trade
Offset by other factors
Incomes abroad
69
Aggregate Demand
The total demand for a country's goods and services at a given price level in a given time period
AD=C+I+G+(X-M)
70
Why does the AD curve slope downward?
Wealth effect (prices fall, people are richer and spend more, C up)
Trade effect (prices fall, exports more competitive, imports less competitive, (X-M) rises)
Interest effect (prices fall, central banks lower interest rates, stimulates higher C and I; lowers ER, increasing (X-M))
71
Determinants of Consumption
USE MPC AND MULTIPLIER EFFECT
Level of real disposable income --> Income Tax
Interest rates/availability of credit
Consumer confidence (job prospects; level of U)
Asset prices (wealth effect)
Household indebtedness
Age composition
72
Determinants of Savings
Level of real disposable income --> Income tax
Interest rates
Inflation
Consumer confidence
Education/culture
Range/trustworthiness of financial institutions
Tax incentives e.g. ISAs, tax-free savings accounts
Age structure of population
Targets e.g. house deposit, uni fees
73
Investment
The addition to the capital stock of the economy - factories, machines, offices and stocks of materials, used to produce other goods and services
74
Human Capital
Education and training of workers become more skilled, therefore more productive
75
Determinants of Investment
Incomes --> expected profits
Changes in technology (needed to remain competitive)
Interest Rates (borrowing costs and 'the hurdle')
Business confidence (expected profit; expected demand in the economy)
Corporation tax (retained profit)
Government incentives
Spare capacity
Level of competition
Price of capital
ACCELERATOR EFFECT
76
Types of Government Spending
Current spending (maintenance of public services and payment of public sector wages)
Capital spending e.g. infrastructure projects
Welfare spending e..g benefits and pensions
Debt interest payments - about £50bn (not an injection)
77
National debt
Total stock of debt over time
Accumulation of budget deficits
78
Determinants of Net Exports
Relative price levels
Exchange rates
Relative incomes
Relative quality
Marketing
Protectionism
79
Factors affecting Short Run Aggregate Supply
Costs of Production:
Raw material/commodity prices
Oil price
Wages
Productivity
Business tax
Import prices
SHOCKS TO THE ECONOMY
80
Factors affecting Long Run Aggregate Supply
Q2CELL/Productive Efficiency
Labour productivity
Investment
Infrastructure
Quantity of labour
Competition
New resource discoveries
81
Classical LRAS
The classical LRAS curve is drawn as vertical because classical economists argue that a country's productive capacity is determined by factors other than price and demand such as investment and innovation
82
Keynesian LRAS
At low levels of economic activity LRAS = elastic
Towards full employment - output at max - LRAS = inelastic
--> at this point LRAS can not be increased without an increase in quantity or improvement in quality of the factors of production
83
Causes of shifts in the LRAS
Expanding the labour supply - e.g. by improving work incentives and relaxing controls on inward labour migration. In the long term many countries must find ways of overcoming the effects of an ageing population and a rising ratio of dependents to active workers
Increase the productivity of labour - e.g. by investment in training of the labour force and improvements in the quality of management of human resources. Productivity can be measured in several ways including output per person employed and output per hour worked
Improve mobility of labour to reduce certain types of unemployment for example structural unemployment caused by occupational immobility of labour. If workers have more skills and flexibility, they will find it easier to get work. Conversely when unemployment remains high, the economy loses out on potential output and there is a waste of scarce resources.
Expanding the capital stock - i.e. increase investment and research and development
Increase business efficiency by promoting greater competition within markets
Stimulate invention and innovation - to promote lower costs and improvements in the dynamic efficiency of markets. Innovation creates new goods and services and encourages investment
84
Impacts of AD shifting right
Growth rises (firms react to increasing demand by producing more --> Output up)
Unemployment falls (labour is a derived demand...)
Inflation rises (more demand --> greater pressure on factors of production, making them more expensive --> costs of production rise --> prices rise)
Trade position worsens (inflation increases, making exports less competitive...; people are richer, so demand for imports rises)
85
Impacts of AS shifting right
Growth rises (extension of AD...)
Unemployment falls (derived demand)
Inflation falls (less competition for goods and services)
Trade position improves (exports more competitive)
86
Fiscal policy
Government policies to manipulate AD
Changing taxation or government spending
87
Benefits of fiscal policy
Can effect C+I+G
Dual effects on AD&AS
Benefit from automatic stabilisers
88
Costs of fiscal policy
Demand pull inflationary pressure
Time lag
Disincentive effects
Some forms of G may be inflexible
Reactions may not be as expected
Financing of the policy may increase the budget deficit burdening future generations
89
Fiscal policy evaluation
Initial level of economic activity
Size of the multiplier
Length of time lag
Offset by other policies
90
Automatic stabilisers
During a recession, government spending automatically rises and tax automatically falls, causing AD to rise without active interference by the government. Opposite in boom. Reduces fluctuations in the business cycle
91
Monetary policy
The use of interest rates and quantitative easing to control inflation
92
Monetary policy - interest rates
A drop in IR reduces the cost of borrowing and reduces the rate of return on saving
Impacts:
Demand for loans
Incentive to save
Discretionary income of those with mortgages
Real incomes of those with savings
Demand for houses; house prices
Exchange rate (X-M)
Drop in IR increases AD, decreases LRAS (Investment)
93
Setting Interest Rates - The Economic Assessment (Demand side)
RGDP growth
Consumer spending
House prices
Unemployment
Business + Consumer confidence
94
Setting Interest Rates - The Economic Assessment (International Factors)
Exchange Rate
Global inflation trends
95
Benefits of Monetary Policy
C, I, X-M all affected with positive multiplier gains
Dual impacts on AD&AS
96
Costs of Monetary Policy
Demand-Pull inflation (especially if increasing money supply)
Time lag (18 months)
Reactions may not be as expected
Interest rates can't fall below 0
97
Evaluation for monetary policy
Depends on:
The initial level of economic activity
The level of consumer/business confidence --> QE
The size of the multiplier
The level of the change in interest rates
Offset by other factors?
98
Limits to the impact of IR changes
There are time lags between changes in rates and their impact on AD, output and prices
There are recognition lags
Changes in interest rates affect exchange rate and competitiveness
Some factors dampen the impact of rate changes:
1) Mortgage rates do not always follow base rate changes
2) Many home owners are on fixed-rate mortgages
3) People in rented property see no direct effect from changes
4) Credit-card lenders may not change rates immediately
99
Supply-side policies
Aim to increase the productive potential of the economy
By increasing quantity/quality of factors of production OR improving the efficiency of markets
Can be interventionist or free market promoting
100
Types of supply-side policies
Making LIFE EPIC
Labour markets (improvements in education/training; Reducing income tax; Abolish the minimum wage; Reduce trade union power; Reduce unemployment benefits)
Industry (Reduce corporation tax; Subsidies to promote R&D)
Free markets (Privatisation; Deregulation)
Efficiency
Efficiency
Productivity
Incentives
Competition
101
Benefits of supply-side policies
All macro objectives improved
Stimulates growth from AD&AS
Sustainable - non-inflationary
102
Costs of supply-side policies
Very expensive --> opportunity cost
Take a long time to work
No guarantee they will work
Will be ineffective with a large amount of spare capacity in the economy
103
Policies to improve short-run (actual) economic growth
Increase AD:
Expansionary fiscal policy
Expansionary monetary policy
Increase SRAS
BUT
Demand pull inflation
Depends on initial level of economic activity, consumer confidence, size of multiplier, time lags etc.
104
Policies to improve long-run (potential) economic growth
Increase LRAS:
Supply side policies
BUT
Time, cost, no guarantee of working, depends on initial level of economic activity
105
Benefits of Economic Growth to consumers
More jobs
Increased standard of living
More choice of goods
Better quality of goods
More wealth
106
Benefits of Economic Growth to Firms
Increased Profits
Greater investment
Innovation
107
Benefits of Economic Growth to Governments
More tax revenue
Less spending on unemployment benefits
108
Costs of Economic Growth
BOP disequilibrium
Growth can be unsustainable
Unfair distribution of income and wealth
Inflation
Environmental problems
Negative externalities (stress etc.)
109
Policies to reduce unemployment
Cyclical: Expansionary monetary/fiscal policies, BUT conflicts with inflation; depends on initial level of economic activity, consumer confidence, size of the multiplier, offsetting factors
Structural: Supply-side policies (occupational); Grants/low-cost housing (geographical), BUT general problems with supply side policies
Frictional: Reduce unemployment benefits; improve job information, BUT no guarantee of working; time lag; opportunity cost
110
Policies to reduce demand-pull inflation
- Contractionary fiscal policy (increase taxes or reduce gov spending)
- Contractionary monetary policy (increase interest rates or make exchange rates stronger to reduce AD)
PROBLEMS = by reducing AD - growth in economy will fall and unemployment will increase (against objectives)
111
Policies to reduce cost-push inflation
- restrict wage prices BUT this could lead to inflexible labour market (no incentive for workers)
- reduce corporation tax which would also increase investment so good
- subsidies BUT may promote inefficiency and reduce incentives for firms to cut waste
- supply-side policies (long-run) BUT standard evaluations
112
Policies to rectify a current account deficit
Contractionary monetary/fiscal policies to lower import spending BUT conflict of lower growth and higher unemployment; depends on...
Protectionism to make imports more expensive; make exports more competitive BUT retaliation; imported inflation; domestic producers face lower competition
Allow currency to depreciate (WIDEC) BUT depends on PED for exports & imports; imported inflation
Supply-side policies BUT standard evaluations
113
Multiplier
The number of times a change in incomes exceeds the change in net injections that caused it e.g. ~1.4 in UK, so if there is a £1m injection, incomes will increase by £1.4m. The formula for this is 1/(1-m.p.c.), or 1/m.p.w, or 1/(m.p.s+m.p.m.+m.p.t.)
