macro Flashcards
1
Q
What is the circular flow of income?
A
A model that illustrates the flow of money around an economy.
2
Q
Explain how the circular flow of income works.
A
- Households provide firms with factors of production<br></br><br></br>2. Firms make goods /services from factors of production<br></br><br></br>3. Households receive factor incomes<br></br><br></br>4. Consumers spend money on goods/services made by firms
3
Q
How do firms pay factor incomes?
A
Land - Rent<br></br>Labour - Wages<br></br>Capital- Interest<br></br>Enterprise - Profit
4
Q
What is the economic definition of investment?
A
When firms spend on capital goods.
5
Q
What is full employment income?
A
The total output of an economy when unemployment is at the governments target.
6
Q
What is an injection?
A
flows of money into the circular flow of income.
7
Q
What is withdrawals/leakages?
A
flows of money leaving the circular flow of income.
8
Q
What are the leakages/withdrawals to the circular flow of income? What letter represents them?
A
S - Savings<br></br>M - Imports<br></br>T - Taxes
9
Q
What are the injections to the circular flow of income? What letter represents them?
A
X - Exports<br></br>I - Investment<br></br>G - Government spending
10
Q
What injections do the government make?
A
Current spending (health, education)<br></br>Capital (Investment)<br></br>Transfers (benefits)
11
Q
What happens when the levels of injections are greater than the level of leakages?
A
- Economic growth increases<br></br>- Circular flow of income expands<br></br>- National income rises
12
Q
What happens when the levels of injections are less than the level of leakages?
A
- Economic growth decreases<br></br>- Circular flow of income shrinks<br></br>- National income falls
13
Q
What happens when the levels of injections are equal than the level of leakages?
A
- The national economy will be in a macro economic equilibrium and there will be no tendency for change
14
Q
What is the multiplier effect?
A
When an injection is made the actual change is greater than the initial injection.<br></br><br></br>This is the multiplier effect.
15
Q
What is the downwards multiplier effect?
A
When a leakage is made the actual change is greater than the initial leakage.<br></br><br></br>This is the downwards multiplier effect.
16
Q
What are other none-core macro economic objectives?
A
- Balanced budget<br></br>- Reduced income inequality<br></br>- Environmental sustainabiltiy
17
Q
What does it mean for the government to have a balanced budget?
A
- Making sure the government keeps control of state borrowing.
18
Q
What are some potential conflicts and trade-offs between the macroeconomic objectives (Growth VS Inflation)?
A
- A growing economy is likely to receive inflationary pressures<br></br>- This can be seen with a positive output gap
19
Q
What are some potential conflicts and trade-offs between the macroeconomic objectives (Growth VS Budget Deficit)?
A
- Reducing a budget deficit requires less expenditure and more tax revenue.<br></br>- This would lead to a fall in AD, leading to less economic growth
20
Q
What are some potential conflicts and trade-offs between the macroeconomic objectives (Growth VS Environment)?
A
- High economic growth is likely to result in high levels of negative externalities, such as pollution and depletion of non-renewable resources
21
Q
What are the 2 main factors that determine LRAS?
A
- Quantity of factors of production<br></br>- Quality of factors of production
22
Q
What can be done to improve the LRAS of an economy?
A
- Improvements in education<br></br>- Technological advancements
23
Q
What does the keynesian (John Maynard Keynes) LRAS curve look like?
A
<img></img>
24
Q
What was Keynes reasoning behind his LRAS curve?
A
- From point X to Y there is spare capacity in the economy as not much is being produced, so increasing output is easy.<br></br><br></br>- From point Y to Z there is a bottleneck as resources start to run out it becomes harder to increase output<br></br><br></br>- At point Z full employment is reached an the economy cant produce any more output.
25
What does the Neoclassical LRAS curve look like?
A vertical straight line
26
What was the reason behind the Neoclassical's LRAS curve?
They believed in the long run an economy would have the time to use up all its resources and become fully efficient at full employment.
27
What does GDP stand for and whats its defintion?
- Gross Domestic Product
- The total market value of goods and services produced within a country's border in a given time period
28
What is real GDP?
Real GDP is the value of GDP adjusted for inflation
29
What is real GDP per capita? What does it give an indication of?
- Real GDP per capita is the value of real GDP divided by the population of the country
- Gives an indication of the living standards of a country
- Gives an indication of the living standards of a country
30
What do CPI/RPI measure?
Inflation in the UK
31
What is CPI? What are the steps for measuring CPI?
- Consumer price index
1. Family Expenditure Survey is carried out
2. The survey finds out what consumers spend their income on.
3. From this, a basket of goods is created. (650)
4. The goods are weighted according to how much income is spent on each item.
1. Family Expenditure Survey is carried out
2. The survey finds out what consumers spend their income on.
3. From this, a basket of goods is created. (650)
4. The goods are weighted according to how much income is spent on each item.
32
What is RPI? How is it different to CPI?
- Retail Price index
- Retail price index including living costs to it total, including mortgage payments, and council tax
- Retail price index including living costs to it total, including mortgage payments, and council tax
33
What are the 2 main measures of unemployment in the UK?
- Claim account
- Labour Force Survey
- Labour Force Survey
34
What is the claimant count?
The number of people seeking Jobs seekers allowance (JSA) from the government
35
What is the Labour force survey? What criteria does it ask for?
- A survey carried out by the International Labour Organisation (ILO) asking people to meet the following:
- Been out of work for 4 weeks
- Able and willing to start working within 2 weeks
- Been out of work for 4 weeks
- Able and willing to start working within 2 weeks
36
How is productivity defined?
Productivity is defined as output per worker per period of time
37
What is the balance of payments?
The balance of payments is a record of all financial transactions made between consumers, firms and the government from one country with other countries
38
What is the balance of payments made up of?
- Current account
- Capital account
- Finacial account
- Capital account
- Finacial account
39
Which of the 2 is a cash inflow or outflow on the balance of payments: Imports and Exports?
Exports are goods bought from foreign consumers, so they are a cash inflow
Imports are goods we buy from foreign countries so they are a cash outflow
Imports are goods we buy from foreign countries so they are a cash outflow
40
What are the possible limitations of GDP as a measure of growth?
- Informal/illegal activity not included in GDP figure
- Huge amount of data required to calculate GDP which can lead to data errors
- Huge amount of data required to calculate GDP which can lead to data errors
41
What are the possible limitations of GDP as a measure of living standards?
- Does not include negative externalities cost (air pollution, depletion of natural resources)
- Does not give an indication of the distribution of income
- Does not measure other quality of life aspects (Education, Healthcare, Happiness)
- Does not give an indication of the distribution of income
- Does not measure other quality of life aspects (Education, Healthcare, Happiness)
42
What is Real GDP per capita? What does is measure that GDP doesnt?
- Real GDP/Population
- It tells us the average measures of individual incomes in the economy, which GDP doesnt
- It tells us the average measures of individual incomes in the economy, which GDP doesnt
43
What are some specific limitations to using GDP per capita as a measure of growth?
- Remittances: people working abroad (GDP per capita does not take into account any factor incomes earned abroad)
- FDI: foreign direct investment (foreign firms operating in a home country increases home countries GDP figure = inaccurate)
- FDI: foreign direct investment (foreign firms operating in a home country increases home countries GDP figure = inaccurate)
44
What is GNI (per capita)? How does it tackle the limitations of GDP per capita as a measure of economic growth?
- Gross National Income: The total income generated by a countries factors of production, regardless of where those factors of production are located
- As long as factors of production are domestic they will be included in GNI
- As long as factors of production are domestic they will be included in GNI
45
What does PPP stand for? What is it?
- Purchasing Power Parity
- A theory that estimates how much the exchange rate needs adjusting so that an exchange between countries is equivalent.
- A theory that estimates how much the exchange rate needs adjusting so that an exchange between countries is equivalent.
46
Why is the PPP important?
- It generally expresses a countries real GDP in terms of dollars which makes it easier for economist to measure the difference in purchasing power and compare living standards.
47
What are the pros and cons of using the claimant account to measure unemployment?
+ Easy to obtain (Just count the number of people claiming unemployment)
+ Updated monthly, so its current
- Excludes people who are looking for wrk but not able to claim JSA
- Can be manipulated easily by the government (e.g. raising school leavers age)
+ Updated monthly, so its current
- Excludes people who are looking for wrk but not able to claim JSA
- Can be manipulated easily by the government (e.g. raising school leavers age)
48
What are the pros and cons of using the labour force survey to measure unemployment?
+ Internationally agreed, so its easier to make comparisons with other countries
+ 'thought' to be more accurate than the claimant account
- expensive/time consuming to collect the data
- may not represent the population as a whole = inaccuracy
+ 'thought' to be more accurate than the claimant account
- expensive/time consuming to collect the data
- may not represent the population as a whole = inaccuracy
49
What are the limitations of using CPI/RPI? (4)
- RPI excludes households in the top 4% of incomes
- CPI doesn't take into account living costs
- Inaccurate representation of a non typical household
- Basket of goods only changes once a year, so it might miss any short term changes in spending habits
- CPI doesn't take into account living costs
- Inaccurate representation of a non typical household
- Basket of goods only changes once a year, so it might miss any short term changes in spending habits
50
What is aggregate demand?
- The total demand for all goods and services in an economy at a given price level in a given time period
51
What is the equation for aggregate demand?
AD = C + I + G + (X-M)
AD = Consumption + Investments + Government Spending + Net exports
AD = Consumption + Investments + Government Spending + Net exports
52
What is the correct % of overall aggregate demand for Consumption, Investment, Government spending and Exports minus imports? (In the UK)
Consumption = 60%
Investment = 14%
Government spending = 25%
Exports - Imports = 1%
Investment = 14%
Government spending = 25%
Exports - Imports = 1%
53
What causes a shift in AD?
- An increase/decrease in any component of C, I, G or (X-M)
54
What is aggregate supply?
The total amount of good and services services supplied in an economy at a given price level in a given time period
55
What causes movements along SRAS?
Only changes in the price level, which occur due to changes in AD, lead to movements along the AS curve.
56
What factors causes SRAS to shift?
When there is an increase/decrease in factor costs
57
What does LRAS show?
The potential supply of an economy in the long run
58
What factors cause LRAS to shift?
When the quantity quality/productivity of factors improves/increases
59
What is disposable income?
How will disposable income impact AD?
How will disposable income impact AD?
- Disposable income is the amount of income consumers have left over after taxes
- When disposable incomes rise AD will shift right because consumer spending will increase
- When disposable incomes fall AD will shift left because consumer spending will decrease
- When disposable incomes rise AD will shift right because consumer spending will increase
- When disposable incomes fall AD will shift left because consumer spending will decrease
60
What impact will interest rates have on AD?
- If they increase, consumers and investors are more likely to save and are less likely to borrow money, shifting AD in
If they decrease, consumers and investors are more likely to borrow and are less likely to save money, shifting AD out
If they decrease, consumers and investors are more likely to borrow and are less likely to save money, shifting AD out
61
How does consumer/investor confidence (animal spirits) impact AD?
- Higher confidence = More spending/Investing > AD shifts out
- Lower confidence = Less spending/Investing > AD shifts in
- Lower confidence = Less spending/Investing > AD shifts in
62
What factors will influence investment?
- Business expectations and confidence
- Government regulations (e.g. Taxes)
- Rate of economic growth
- Government regulations (e.g. Taxes)
- Rate of economic growth
63
What is accelerator effect? How does it shift AD?
- The accelerator effect is when an increase in real GDP signals to firms that the economy is demanding more, and will therefore increase the rate they invest.
- AD shifts to the right.
- AD shifts to the right.
64
How can exchange rates influence AD?
- A depreciation of the pound means imports are more expensive, and exports are cheaper, so the current account trade deficit narrows.
- Shifts AD to the right
- Shifts AD to the right
65
What sort of economic activity can cause changes in AD?
- Employment: influences production and consumption
- Confidence: influences the level of spending and investment
- Events: natural disasters or Christmas influence the level of consumer spending
- Confidence: influences the level of spending and investment
- Events: natural disasters or Christmas influence the level of consumer spending
66
How can an initial increase in AD leads to an even bigger increase in national income via the multiplier effect?
1. An injection of more income is made into the circular flow of income, which leads to economic growth.
2) This leads to more jobs being created, higher average incomes, more spending,
3) Eventually, more income is created.
2) This leads to more jobs being created, higher average incomes, more spending,
3) Eventually, more income is created.
67
What is the multiplier ratio?
The multiplier ratio tells us how much GDP will increase in total following an initial injection into the economy.
68
What is the marginal propensity to consume (MPC)?
How much a consumer changes their spending following a change in disposable income
69
What is the relationship between the MPC and the multiplier?
The higher the MPC the greater the impact of the multiplier
70
How is the multiplier calculated?
1/(1-MPC)
71
What are 2 factors that determine SRAS?
- Price Level
- Production costs
- Production costs
72
Why is the profit motive not relevant when looking at SRAS?
- When the price level increases, the price of everything increases keeping profits the same.
73
Why is SRAS upward sloping? Explain with an example.
- In the short run, increasing output increases costs so the price level increases.
- For example, if labour in a pizza shop is fixed and there is a sudden increase in demand, in the short run labour cannot be increased, so workers are payed more increasing costs of production. Prices must be raised to cover the costs raising the price level.
- For example, if labour in a pizza shop is fixed and there is a sudden increase in demand, in the short run labour cannot be increased, so workers are payed more increasing costs of production. Prices must be raised to cover the costs raising the price level.
74
What are the 4 types of production costs may cause SRAS to shift?
- Wages
- World comodity prices
- Business rates/VAT
- Import Prices
- World comodity prices
- Business rates/VAT
- Import Prices
75
What are commodities? How can their prices cause SRAS to shift?
- Common goods: Fossils fuels, wheat, steal
- Increase in price will shift SRAS in- Decrease in price will shift SRAS out
- Increase in price will shift SRAS in- Decrease in price will shift SRAS out
76
What is economic growth?
An increase in real GDP over time caused by an increase in AD or LRAS
77
What is short run growth? What is it caused by?
- Short run growth is the percentage increase in a country's real GDP, measured annually.
- It is caused by increases in AD.
- It is caused by increases in AD.
78
How can short run growth be represented on a Macro PPF?
- Movement from a point inside the PPF towards a point on/closer to the boundary
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79
How can short run growth be represented on an AD/LRAS model?
- AD shifts right
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80
What is long run growth? What is it caused by?
- Long run economic growth occurs when the productive capacity of the economy is increasing
- It is caused by increases in LRAS.
- It is caused by increases in LRAS.
81
How can long run growth be represented on a Macro PPF?
Macro PPF shifts out
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82
How can long run growth be represented on a AD/LRAS model
- Right shift in LRAS
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83
What is the most ideal from of growth for an economy?
- A right shift in LRAS & AD
- This leads to non-inflationary growth
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- This leads to non-inflationary growth
84
What is the economic cycle?
What are the 4 stages?
What does the diagram look like?
What are the 4 stages?
What does the diagram look like?
- The stages of economic growth that the economy goes through.
- Boom, Slump, Recession, Recovery
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- Boom, Slump, Recession, Recovery
85
Why is potential trend GDP an upwards sloping line?
- In the long run, improvements in technology increase potential trend GDP
86
What is a recessions?
What are the characteristics of a recessions? (5)
What are the characteristics of a recessions? (5)
- 2 consecutive quarters of negative economic growth
- Low animal spirits
- Low inflation/deflation
- High unemployment
- Government budget worsens
- Negative economic growth
- Low animal spirits
- Low inflation/deflation
- High unemployment
- Government budget worsens
- Negative economic growth
87
What are the characteristics of a boom? (5)
- High animal spirits
- Demand pull inflation
- High economic growth
- Low unemployment
- Improved government budget (More tax revenue, less spending on transfers)
- Demand pull inflation
- High economic growth
- Low unemployment
- Improved government budget (More tax revenue, less spending on transfers)
88
What is a positive output gap?
What are 2 reasons why positive output gap are not sustainable?
What are 2 reasons why positive output gap are not sustainable?
- When actual growth is greater than potential trend growth
- Workers are being overworked, Machinery is being overused
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- Workers are being overworked, Machinery is being overused
89
How can a positive output gap be shown on an AD/AS/Neoclassical LRAS diagram?
What is key to remember about output gaps on a neoclassical LRAS diagram?
What is key to remember about output gaps on a neoclassical LRAS diagram?
- NO long run output gaps, Only short run output gaps
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90
What is a negative output gap?
What may happen during a negative output gap?
What may happen during a negative output gap?
- When actual growth is below than potential trend growth
- Workers are unemployed and capital is not used
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- Workers are unemployed and capital is not used
91
How can a negative output gap be shown on a AD/AS/Neoclassical LRAS diagram?
What is key to remember about output gaps on a neoclassical LRAS diagram?
What is key to remember about output gaps on a neoclassical LRAS diagram?
- NO long run output gaps, Only short run output gaps
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92
On a Keynesian LRAS diagram, what type of output gaps can be shown? Is this in the short run or long run?
- Negative output gaps only
- In the long run
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- In the long run
93
What are the benefits of economic growth?
- Higher disposable income + Lower unemloyment = Improved living standards
- Higher profits for firms
- More Fiscal dividend (increased tax revenue)
- Higher profits for firms
- More Fiscal dividend (increased tax revenue)
94
What are the costs of economic growth?
- Demand pull inflation
- Environmental costs
- Income inequality (e.g. if growth comes from one sector incomes are contained to that sector)
- Environmental costs
- Income inequality (e.g. if growth comes from one sector incomes are contained to that sector)
95
What is fiscal policy?
Fiscal policy is a demand side policy that involves the manipulation of government spending, taxation and the budget balance in order to achieve the macroeconomic objectives
96
What is the difference between expansionary and contractionary fiscal policy?
- Expansionary fiscal policy involves the government reducing tax and increasing spending
- Contractionary fiscal policy involves the government increasing tax and reducing spending
- Contractionary fiscal policy involves the government increasing tax and reducing spending
97
What are the main objectives of expansionary fiscal policy? (4)
- Economic growth
- Increase inflation
- Reduce unemployment
- Redistribute income
- Increase inflation
- Reduce unemployment
- Redistribute income
98
What are the main objectives of contractionary fiscal policy?
- Reduce inflation
- Reduce budget deficit/current account deficit
- Slowdown economic growth during 'boom' phases
- Reduce budget deficit/current account deficit
- Slowdown economic growth during 'boom' phases
99
What is the difference between deficit and debt?
- Deficit is when expenditure is greater than tax revenue in a given finacial year
- Debt is the accumulation of the governments deficit over time
- Debt is the accumulation of the governments deficit over time
100
What are the consequences of running a budget deficit?
- Demand pull inflation
- Increases national debt: since the UK issue bonds to borrow money, as they get more into debt they are seen as less able to pay back money, so to borrow more they must increase the interest rates on their bonds, which could lead to further debt
- Crowding out private investment: since government spend/borrow more they reduce the money supply for the rest of the economy. This means that interest rates increase making it harder for private firms to invest
- Increases national debt: since the UK issue bonds to borrow money, as they get more into debt they are seen as less able to pay back money, so to borrow more they must increase the interest rates on their bonds, which could lead to further debt
- Crowding out private investment: since government spend/borrow more they reduce the money supply for the rest of the economy. This means that interest rates increase making it harder for private firms to invest
101
What is the role of The Office for Budget Responsibility?
- A non governmental public body that provides analysis of the UK's finances
- It uses forecasts to evaluate the governments performance againsts its fiscal targets
- They asses whether the government have a greater than 50% probability of hitting these targets under current policy, using historical evidences and comparing alternative scenarios.
- It uses forecasts to evaluate the governments performance againsts its fiscal targets
- They asses whether the government have a greater than 50% probability of hitting these targets under current policy, using historical evidences and comparing alternative scenarios.
102
What is the difference between a cyclical and structual budget balance?
- A cyclical budget is influenced by the state of the economy and occurs short term
- A strucual budget is not influenced by the state of the economy and will occur even if the economy is working at its full potential
*ask for more clarification as to why these would occur
- A strucual budget is not influenced by the state of the economy and will occur even if the economy is working at its full potential
*ask for more clarification as to why these would occur
103
What factors could influence a budget deficit?
- Reccessions/Pandemics
- Demograhics: ageing population means increase demand for state pensions, increase deficit
- Subsidies/Grants
- Demograhics: ageing population means increase demand for state pensions, increase deficit
- Subsidies/Grants
104
What is the difference between a direct and an indirect tax?
- Direct taxes are imposed on income or profits and are paid directly to the government e.g. Income tax, Corporation tax, Council tax
- Indirect taxes are imposed on expenditure on goods and services increasing production costs which are passed onto consumers in the form of higher prices e.g. sugar tax
- Indirect taxes are imposed on expenditure on goods and services increasing production costs which are passed onto consumers in the form of higher prices e.g. sugar tax
105
What are the principles of taxation? (6)
106
What are the 3 types of taxes?
Progressive, Proportional and Regressive
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107
What is a progressive tax?
A type of tax structure whereby the marginal rate of tax rises as incomes rise
108
What is a proportional tax?
A type of tax structure whereby the same tax rate is paid regardless of income e.g. VAT is the same for the local conershop and Apple/Starbucks/Google
109
What is a regressive tax?
A type of tax structure that imposes higher tax rates for lower income earners e.g. excise duties on alcohol, cigarettes
110
What is a key positive about fiscal policy?
- Fiscal policy time lags are much shorter and its effects can be easily felt
111
What is a key negative about fiscal policy?
- Government may have imperfect information about spending leading to ineffecient spending
112
What is the Laffer Curve?
- A curve which shows how much money the government can raise from taxes and at what point the government will start to lose revenue from taxes.
- The highest point is seen as the 'optimal' tax rate
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- The highest point is seen as the 'optimal' tax rate
113
What is a supply side policy?
Any government policy that aims to increase the productive potential of an economy by increasing the quantity/quality of factors of production
114
What are 2 types of supply side policies?
- Interventionist policy
- Market based policy
- Market based policy
115
What is an interventionist policy?
When the government increases its intervention in the economy e.g. by spending on infastructure, education and training, subsidies
116
What is a market based policy?
When the government use policies to increase AS without or very little intervention e.g. tax cuts, privitisation, deregulation
117
What are the advantages of the government increasing infastructure spending as a interventionist policy? (2)
- Infrastructure projects such as HS2 improve the geographical mobility of labour, increasing the productivity of labour and causing the LRAS to shift out.
- Since government spending is a component of AD this will also lead to a right shift in AD, increasing economic growth.
- Since government spending is a component of AD this will also lead to a right shift in AD, increasing economic growth.
118
What are the disadvantages of the government increasing infastructure spending as a interventionist policy?
- Government spending on infrastructure might crowd out private firms.
- By borrowing money to spend on new infrastructure, the government is increasing the demand for borrowed money, land, labour and capital. This increases prices for each factor of production, increasing costs for firms. This shifts the SRAS in and reduces real GDP.
- By borrowing money to spend on new infrastructure, the government is increasing the demand for borrowed money, land, labour and capital. This increases prices for each factor of production, increasing costs for firms. This shifts the SRAS in and reduces real GDP.
119
What are the advantages of the government reducing coporation taxes as a market based policy? (3)
Advantage 1 - A reduction in corporation tax will reduce the cost of production. This will Incentivise new firms and existing firms to expand production which will shift the SRAS to the right and leads to economic growth and a reduction in the price level.
Advantage 2 - Firms can keep more of their profit and so they are more likely to invest. This will increase the productivity of capital and shift LRAS to the right leading to economic growth and a reduction in the price level.
Advantage 3 - Firms can keep more of their profit and so they are more likely to invest. Investment is a component of AD and so an increase in investment will increase AD which will lead to economic growth.
Advantage 2 - Firms can keep more of their profit and so they are more likely to invest. This will increase the productivity of capital and shift LRAS to the right leading to economic growth and a reduction in the price level.
Advantage 3 - Firms can keep more of their profit and so they are more likely to invest. Investment is a component of AD and so an increase in investment will increase AD which will lead to economic growth.
120
What are the disadvantages of the government reducing coporation taxes as a market based policy?
- A reduction in corporation tax may reduce tax revenue. There is an opportunity cost as there is now less money available to spend in other areas, such as healthcare or infrastructure.
121
What are the advantages of the government reducing minimum wage as a market based policy?
- A decrease in wage costs will decrease the cost of production for firms, which will increase short run aggregate supply.
122
What are the disadvantages of the government reducing minimum wage as a market based policy?
Disadvantage 1 - a reduction in the minimum wage will reduce disposable income for many households. This will reduce consumption and decrease aggregate demand.
Disadvantage 2 - a reduction in the minimum wage may mean that workers emigrate from the UK in search of higher wages. This will reduce LRAS and reduce economic growth.
Disadvantage 2 - a reduction in the minimum wage may mean that workers emigrate from the UK in search of higher wages. This will reduce LRAS and reduce economic growth.
123
What is the impact of deregulation as a supply side policy?
- Deregulation can reduce costs of entering an industry for firms leading to a right shift in SRAS
- For example, in the taxi industry the removal of taxi license tests allowed for more taxis to enter the market
(Uber gained an extra 50,000 taxis as a result of this)
- For example, in the taxi industry the removal of taxi license tests allowed for more taxis to enter the market
(Uber gained an extra 50,000 taxis as a result of this)
124
What is the impact of privitisation as a supply side policy?
- When firms are privitised, there are pressures that arise from investors to maximise profits, forcing firms to cut costs, leading to a right shift in SRAS
- E.g. in the 1980's when Margret Thatcher privitised BT, British Gas and British Airways
- E.g. in the 1980's when Margret Thatcher privitised BT, British Gas and British Airways
125
What are the advantages and disadvantages of education spending as a interventionist policy?
Advantage - subsidies (spending on education) allow universities to offer their courses at a lower price, which will encourage more students to pursue higher education. Over time, this will make workers more productive and lead to an increase in labour supply. The LRAS shifts to the right and the economy grows.
Disadvantage - in the short run, education subsidies lead to a decrease in the supply of labour as more people spend their time studying instead of working. This leads to an increase in wages which increases the cost of production and reduces SRAS, leading to a reduction in economic growth in the short run.
Disadvantage - in the short run, education subsidies lead to a decrease in the supply of labour as more people spend their time studying instead of working. This leads to an increase in wages which increases the cost of production and reduces SRAS, leading to a reduction in economic growth in the short run.
126
What is the impact of reducing income taxes as a market base supply side policy?
Reducing income tax means that workers get to keep more of their earnings and so disposable income increases. This is likely to increase the number of hours they choose to work and so there will be an increase in labour supply. This will decrease wages which will decrease the cost of production. This will shift the SRAS to the right, increasing real GDP.
However, an increase in disposable income could cause some workers to decrease their labour supply as they now need to work less to earn the same amount of money. This might lead to a decrease in labour supply. This will increase wages which will increase the cost of production. This will shift the SRAS to the left, limiting economic growth.
Reducing income taxes will also have a demand side effect since consumers will have more money left over to spend which will shift AD to the right.
However, an increase in disposable income could cause some workers to decrease their labour supply as they now need to work less to earn the same amount of money. This might lead to a decrease in labour supply. This will increase wages which will increase the cost of production. This will shift the SRAS to the left, limiting economic growth.
Reducing income taxes will also have a demand side effect since consumers will have more money left over to spend which will shift AD to the right.
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What are the advantages and disadvantages of reducing benefits payments as a market based policy?
Advantage - A reduction in spending on benefits will increase the incentive to work. This will increase labour supply and reduce wages which in turn will reduce the cost of production. SRAS will increase leading to an increase in economic growth and a decrease in the price level.
Disadvantage - reduction in spending on benefits means that less money is transferred to unemployed workers and low income households. This means that they will have less disposable income and must reduce their spending. This will decrease consumption which will lead to a decrease in AD.
Disadvantage - reduction in spending on benefits means that less money is transferred to unemployed workers and low income households. This means that they will have less disposable income and must reduce their spending. This will decrease consumption which will lead to a decrease in AD.
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What are the advantages and disadvantages of healthcare spending as a market based supply side policy?
Advantage - increasing spending on healthcare will increase the productivity of labour. This will shift the LRAS to the right, increasing economic growth.
Disadvantage - spending on the NHS may be inefficient and of poor quality. If funding is increased, it is not given that all the extra funds will go towards increasing productivity and so the effects on LRAS will be limited.
Disadvantage - spending on the NHS may be inefficient and of poor quality. If funding is increased, it is not given that all the extra funds will go towards increasing productivity and so the effects on LRAS will be limited.
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What is monetary policy?
Monetary policy is a demand side policy whereby the central bank manipulates the base interest rate or the money supply in order to influence aggregate demand, independent of the goverment.
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What is a base interest rate?
The interest rate the the central bank sets to other banks when they need to borrow money
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What is a positive impact on savings when the interest rate is lowered?
1. If the base interest rate is reduced, it will mean returns on savings also decrease.
2. This will encourage spending since the cost of borrowing has also fallen
3. This will increase consumption and since this is a component of AD, AD will shift to the right creating demand-pull inflation
2. This will encourage spending since the cost of borrowing has also fallen
3. This will increase consumption and since this is a component of AD, AD will shift to the right creating demand-pull inflation
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What is a negative impact on savings when the interest rate is lowered?
1. A reduction in the base interest rate will reduce the return on savings.
2. This means that consumers that rely on savings for income like pensioners have less disposable income.
3. They will spend less and this will reduce consumption, which is a component of aggregate demand.
4. The AD curve will shift to the left and there will be a fall in real GDP.
2. This means that consumers that rely on savings for income like pensioners have less disposable income.
3. They will spend less and this will reduce consumption, which is a component of aggregate demand.
4. The AD curve will shift to the left and there will be a fall in real GDP.
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What is the positive impact on savings when the interest rates are increased?
1. An increase in the base interest rate will mean that the cost of borrowing is reduced and the reward for saving increases. This will reduces consumers MPC and increase their MPS
2. They will spend less and this will reduce consumption, which is a component of aggregate demand.
3. The AD curve will shift to the left and there will be reduced inflation, the desired outcome
2. They will spend less and this will reduce consumption, which is a component of aggregate demand.
3. The AD curve will shift to the left and there will be reduced inflation, the desired outcome
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What is the negative impact on savings when the interest rates are increased?
1. An increase in the base interest rate may increase consumption for pensioners as they are receiving higher returns on their savings.
2. However, an increase in consumption will shift AD out which may lead to demand-pull inflation, not deflation.
2. However, an increase in consumption will shift AD out which may lead to demand-pull inflation, not deflation.
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What is the positive impact on mortgages when the interest rates are reduced?
1. Reducing the base interest rates reduces the interest on mortgages.
2. This reduces the cost of mortgages making them more affordable so more will be taken out, increasing the demand and price of houses
3. An increase in the price of houses will lead to a positive wealth effect as consumers will feel more wealthy and therefore spend more
4. Since consumption is a component of AD, AD will shift to right leading to economic growth.
2. This reduces the cost of mortgages making them more affordable so more will be taken out, increasing the demand and price of houses
3. An increase in the price of houses will lead to a positive wealth effect as consumers will feel more wealthy and therefore spend more
4. Since consumption is a component of AD, AD will shift to right leading to economic growth.
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What is the negative impact on mortgages when the interest rates are reduced?
In European countries the wealth effect is almost 0% as shown by the research of the economist Ricardo Sousa
This is because an increase in house prices makes everyone who is saving up for a house feel poorer e.g. London where 76% of people do not own their homes
As a result consumers will feel they need to save more for houses reducing consumption canceling out the positive wealth effect
This is because an increase in house prices makes everyone who is saving up for a house feel poorer e.g. London where 76% of people do not own their homes
As a result consumers will feel they need to save more for houses reducing consumption canceling out the positive wealth effect
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What is the positive impact on mortgages when the interest rates are increased?
1. If the base interest rate increases, it increases the cost of mortgages so demand and price of houses will decrease
2. This will mean home owners will see a fall in the value of there homes causing a negative wealth effect.
3. As consumers are feeling less wealthy they will reduce spending, reducing 'C' leading to a left shift in AD reducing inflation which is the intended target
2. This will mean home owners will see a fall in the value of there homes causing a negative wealth effect.
3. As consumers are feeling less wealthy they will reduce spending, reducing 'C' leading to a left shift in AD reducing inflation which is the intended target
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What is the negative impact on mortgages when the interest rates are increased?
Wealth effect is almost 0% in European countries as shown by the research of the economist Ricardo Sousa
This will mean when house prices decrease people who are saving for houses will feel richer, like in London where 76% of people dont their homes
This creates less pressure to save, potentially increasing consumption and canceling out the negative wealth effeect
This will mean when house prices decrease people who are saving for houses will feel richer, like in London where 76% of people dont their homes
This creates less pressure to save, potentially increasing consumption and canceling out the negative wealth effeect
139
What is the positive impact on investment when the interest rates are reduced?
1. A reduction in the base interest rate will increase investment, since the cost of borrowing becomes cheaper.
2. Investment is a component of aggregate demand and so this will shift out.
3. Investment will also increase productivity which will cause the long run aggregate supply curve to shift out and increase real GDP.
2. Investment is a component of aggregate demand and so this will shift out.
3. Investment will also increase productivity which will cause the long run aggregate supply curve to shift out and increase real GDP.
140
Why may decreasing the interest rates not always be good for firms investments?
If aggregate demand and animal spirits are particularly low, firms might be concerned that investment will be wasted.
This could mean that they do not make a profit on the investment, leaving them unable to pay it back and therefore in debt.
So, a decrease in the interest rate might not actually increase investment and economic growth.
This could mean that they do not make a profit on the investment, leaving them unable to pay it back and therefore in debt.
So, a decrease in the interest rate might not actually increase investment and economic growth.
141
What is the positive impact on investment when the interest rates are increased?
1. An increase in the interest rate means that firms will have higher repayments when they borrow.
2. This will lead to a reduction in investment which is a component of aggregate demand.
3. A reduction in AD should decrease the price level and reduce the rate of inflation, the intended target.
2. This will lead to a reduction in investment which is a component of aggregate demand.
3. A reduction in AD should decrease the price level and reduce the rate of inflation, the intended target.
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What is a negative impact on investments when the interest rates are increased?
1. If the base interest rate increases, firms repayments on loans will also increase
2. This will increase the cost of production for firms. As a result, they will increase prices to remain profitable.
3. This will result in cost-push inflation.
2. This will increase the cost of production for firms. As a result, they will increase prices to remain profitable.
3. This will result in cost-push inflation.
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What will the impact on net exports be when there is an increase in interest rates?
1. An increase in the base interest rate will mean there is now higher return on savings from UK banks.
2. This will cause an increase in the demand for the pound from foreign investors so they can save their money in the UK.
3. This will then lead to an appreciation of the pound, meaning imports get cheaper and exports get more expensive
4. Import expenditure increases and export revenue decreases, which means 'X-M' decreases and AD shifts to the left
2. This will cause an increase in the demand for the pound from foreign investors so they can save their money in the UK.
3. This will then lead to an appreciation of the pound, meaning imports get cheaper and exports get more expensive
4. Import expenditure increases and export revenue decreases, which means 'X-M' decreases and AD shifts to the left
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Why may an increase in interest rates not worsen net exports?
The UK is a net importer of raw materials
An appreciation of the pound will reduce the cost of production for firms who import raw materials.
This will reduce their prices and increase the international competitiveness of UK exports.
This will increase demand for UK exports and increase export revenue.
An appreciation of the pound will reduce the cost of production for firms who import raw materials.
This will reduce their prices and increase the international competitiveness of UK exports.
This will increase demand for UK exports and increase export revenue.
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What is the impact on net exports when interest rates are reduced?
1. A lower base interest rate in the UK means investors will want to sell their pounds in order to buy other currencies.
2. This will increase the supply of pounds and cause the value of the pound to depreciate.
3. A weaker pound means imports become more expensive and exports are cheaper for foreign consumers. This will result in in reduced import expenditure and increased export revenue
4. AD shifts to the right, the desired outcome
2. This will increase the supply of pounds and cause the value of the pound to depreciate.
3. A weaker pound means imports become more expensive and exports are cheaper for foreign consumers. This will result in in reduced import expenditure and increased export revenue
4. AD shifts to the right, the desired outcome
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Why may the impact of decreased base interest rate on net exports not lead to an increase in AD?
The UK is a net importer of raw materials.
This means if imports are more expensive, raw materials become more expensive aswell. This raises firms cost and as a result will raise their prices as a result to remain profitable.
This will make UK exports less competitive reducing their demand and reducing export revenue
Also Consumers will switch to cheaper imports from alternative countries
This will reduce 'X' and increase 'M' leading to a left shift in AD
This means if imports are more expensive, raw materials become more expensive aswell. This raises firms cost and as a result will raise their prices as a result to remain profitable.
This will make UK exports less competitive reducing their demand and reducing export revenue
Also Consumers will switch to cheaper imports from alternative countries
This will reduce 'X' and increase 'M' leading to a left shift in AD
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What is a potential negative of quantitative easing?
The increase in the money supply may cause an increase in the price level. High inflation could become hyperinflation.
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What is the quantity theory of money? (Fishers Equation)
It is a theory that predicts that quantitaive easing will lead to an increase in the money supply increaing the price level and therefore lead to inflation
MV = PQ (Money supply x Velocity = Price level x Quantity of goods/services)
MV = PQ (Money supply x Velocity = Price level x Quantity of goods/services)
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What will happen if The Bank Of England fail to achieve the inflation target?
The MPC have to write a letter to the chancellor of the exchequer explaining why this has happened
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What are some factors that the Bank Of England consider when setting the interest rates?
- Wage rates: If wage rates are growing then we would expect consumption to increase, leading to an outward shift in aggregate demand or AD and upwards pressure on the price level .
- Savings rate: If the savings rate is increasing, then it would suggest that consumption rates are falling or decreasing . As a result, aggregate demand or AD may be at risk of shifting inwards and putting downward pressure on the price level.
- External Shocks: Like the finacial crisis of 2007-08 which initially started in the USA and it quickly brought the threat of negative growth and malignant deflation
- Savings rate: If the savings rate is increasing, then it would suggest that consumption rates are falling or decreasing . As a result, aggregate demand or AD may be at risk of shifting inwards and putting downward pressure on the price level.
- External Shocks: Like the finacial crisis of 2007-08 which initially started in the USA and it quickly brought the threat of negative growth and malignant deflation
151
What are automatic stabilisers?
Automatic stabilisers are fiscal policy tools which automatically trigger by changes in the business cycle and are designed partly to smooth out fluctuations in the business cycle. (less volatile, smaller booms and smaller slumps)
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What are some characteristiscs of money?
- Durability: it needs to last
- Portable: Easy to carry around
- Divisible: Broken into smaller denominations
- Hard to counterfeit
- Portable: Easy to carry around
- Divisible: Broken into smaller denominations
- Hard to counterfeit
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What is meant by money supply?
The total supply of money in the economy
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What is the difference between narrow money and broad money?
Narrow money is cash and money in debit credit card accounts (basically money which is ready to be spent immediately)
Broad money is harder to access and cant be spent immediately (Savings, Cheques, Government bonds)
Broad money is harder to access and cant be spent immediately (Savings, Cheques, Government bonds)
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What is the money market?
Where you can buy short-term financial assets e.g. short terms loans and overdrafts
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What is the capital market?
Where you can buy and sell long-term financial assets e.g. larger bank loans to MNC's
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What is the foreign exchange market?
Where you can buy and sell currencies e.g. $
158
What are the 2 ways a company can raise finances through debt?
They can borrow money by taking out a loan from the bank, or they can borrow money from investors by issuing corporate bonds.
They must pay back the same amount + interest
They must pay back the same amount + interest
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How can a company raise finance through equity?
A company can raise finance through equity which is where they sell a percentage of the company to investors using shares.
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What is meant by maturity, payoff and coupon rate?
Maturity = The date which the final interest on a bond must be paid
Coupon rate = Annual interest rate the government pays on the bond.(interest rate based on the original price of the bond)
Payoff = the amount the bondholder receives in interest per year from the government (not a percentage)
Coupon rate = Annual interest rate the government pays on the bond.(interest rate based on the original price of the bond)
Payoff = the amount the bondholder receives in interest per year from the government (not a percentage)
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What is the difference between commercial banks and investment banks?
- Commercial banks are banks which deal with ordinary, everyday stuff like putting in money into a savings account, taking out a mortgage and withdrawing cash.
- Investment banks are banks which make investments to make money e.g. Goldman Sachs, Morgan and Stanley
- Investment banks are banks which make investments to make money e.g. Goldman Sachs, Morgan and Stanley
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What is the difference between assets and liabilities? Examples include...
- Assets include money the bank has e.g. Cash, Loans
- Liabilities include money the bank owes e.g. Deposits
- Liabilities include money the bank owes e.g. Deposits
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What is the profit-liquidity trade off?
The more loans a bank lends out the more profit it can make, but the less cash it has to repay consumers
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164
How are liquidity ratios calculated?
165
What does it mean to have a high or low capital ratio?
High = Good because if the bank is running low on cash then it can use some of the owners money to help out
Low = Bad because if the bank is running low on cash it cant rely on the owners money, which may cause the bank to go bankrupt
Low = Bad because if the bank is running low on cash it cant rely on the owners money, which may cause the bank to go bankrupt
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What are the 4 functions of money?
- Median of exchange
- Store of value
- Unit of account
- Standard of deferred payment
- Store of value
- Unit of account
- Standard of deferred payment
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What are some roles of financial markets in the wider economy?
- Facilitate savings: provide somewhere for consumers and firms to save their funds
- Bring together lenders and borrowers
- Facilitate the exchange of goods and services
- Bring together lenders and borrowers
- Facilitate the exchange of goods and services
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What is a bond?
A bond is a type of IOU which promises the holder of the bond annual interest payments and the nominal value of the bond when it matures
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What is the relationship between the market price of a bond and the yield of a bond?
If the Price increases the yield decreases: Fixed number/Increasing number
If the Price decreases the yield increases: Fixed number/decreasing number
If the Price decreases the yield increases: Fixed number/decreasing number
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How does interest rates affect the market price and yield of government bonds?
- Generally the government aim to issue coupon rates similar to interest rates charged by other financial institutes in the economy to remain competitive
- If the interest rate on government bonds is greater than other financial institutes demand for bonds will increase, increasing the market price. Yields will then decrease to match other institutes in the economy
- If the interest rate on governmet bonds is less than other financial institutes demand for bonds will decrease, reducing the market price. Yields will then increase to match other institutes in the economy
- If the interest rate on government bonds is greater than other financial institutes demand for bonds will increase, increasing the market price. Yields will then decrease to match other institutes in the economy
- If the interest rate on governmet bonds is less than other financial institutes demand for bonds will decrease, reducing the market price. Yields will then increase to match other institutes in the economy
171
What are the main functions of a commercial bank?
- Lend
- Act as financial intermediaries
- Allow payouts from one agent to another
- Act as financial intermediaries
- Allow payouts from one agent to another
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What are some of the main functions of an investment bank?
- Proprietary trading: taking any excess capital that investment banks may have and investing it
- Market making: creating markets whereby agents can buy and sell finacial assets e.g. stocks bonds IOU's
- Market making: creating markets whereby agents can buy and sell finacial assets e.g. stocks bonds IOU's
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What is systemic risk? How does it relate to the financial sector?
- Systemic risk is the idea that a single event that can trigger a collapse in a certain industry or economy
- When banks that engage in both commecial and investment activity increase their risk of bank failure, because if one side fails it may cause the other to fail
- Since banks are more interconnected these days, a bank failure for 1 bank may cause an entire financial market crash
- When banks that engage in both commecial and investment activity increase their risk of bank failure, because if one side fails it may cause the other to fail
- Since banks are more interconnected these days, a bank failure for 1 bank may cause an entire financial market crash
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What is the main objective of a commercial bank?
The main objective of a commercial bank is to profit maximise to satisfy shareholders.
The idea is to borrowing short term (low interest) and lending long term (high interest)
The idea is to borrowing short term (low interest) and lending long term (high interest)
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What are ways that commercial banks can increase profits?
- Lend to borrowers that are seen as more risky so higher interest rates can be charged
- Offering loans that are not backed by anything so again higher interest rates can be charged
- Offering loans that are not backed by anything so again higher interest rates can be charged
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What will a commercial bank aim to do to reduce excessive risk?
- High liquidity to avoid bank runs
- Security to manage risk and avoid insolvency
- Security to manage risk and avoid insolvency
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What is meant by insolvency?
When liabilities are greater than assets
178
What is primary role of the central bank?
- Conduct monetary policy with the aim of achieving stable prices (2% inflation +/-1%) and confidence in the currency
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What are some other functions of the central bank?
- Acts as a banker to the government: buy and sell bonds on behalf of the government and have functions that reduce the interest rate the governments pay on bonds
- Act as a banker to the banks (The lender of last resort): in the UK, the Bank Of England have a function called the liquidty assurance scheme. They can offer non-emergency liquidity and emergency liquidity
- Regulate the financial system
- Act as a banker to the banks (The lender of last resort): in the UK, the Bank Of England have a function called the liquidty assurance scheme. They can offer non-emergency liquidity and emergency liquidity
- Regulate the financial system
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What is the difference between spot currency markets and futures?
- Spot currency markets involve buying currencies at the given exchange rate and having it delivered immediately
- Futures markets involve buying currencies at the given exchange rate anf having it delivered at a future date
- Futures markets involve buying currencies at the given exchange rate anf having it delivered at a future date
181
What is the balance sheet equation for a commercial bank?
Assets = Liabilites + Capital (owners money in the bank)
182
What are the 5 types of financial market failure?
SA MM Nege
183
How can asymmetric information lead to financial market failure?
For example, before the 2008 crisis, bankers had more info about the sub prime mortgages that were being sold to low skilled/paid people (teaser rates) and the financial regulators
184
How can speculation and market bubbles lead to market failure?
- Examples included Tulips plants in Netherlands 1600, Dot.com bubble, bubble housing bubble in 2008.
- In all these situations the price of goods were rising so people speculated that the price would increase so more were produced and sold increasing demand and price creating a bubble, that eventually burst
- In all these situations the price of goods were rising so people speculated that the price would increase so more were produced and sold increasing demand and price creating a bubble, that eventually burst
185
How can negative externalities cause further financial market failure?
- Many people not directly involved in causing these crashes are affected
- For example, firms are unable to borrow from banks since they have less money and firms then lay off workers as a result
- For example, firms are unable to borrow from banks since they have less money and firms then lay off workers as a result
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Why is moral hazard a cause of financial market failure?
- If the banks happen to screw up and go bankrupt, they will just be bailed out by governments/central banks, and do not learn from mistakes
187
How can market rigging lead to financial market failure?
- This is where firms unfairly try to control prices which distorts the price mechanism .
- One of the most famous examples of market rigging is LIBOR (global bench mark interest rate) or London Interbank Offered Rate where Barclays would give inaccurate numbers changing the averages
- As a result they were fined $450 Million
- One of the most famous examples of market rigging is LIBOR (global bench mark interest rate) or London Interbank Offered Rate where Barclays would give inaccurate numbers changing the averages
- As a result they were fined $450 Million
188
What are the 3 departments in the UK responsible for financial regulation? What is the name of this system?
A tripartide system of regulation:
- Financial Policy Committee (FPC)
- Prudential Regulation Authority (PRA)
- Financial Conduct Authority (FCA)
- Financial Policy Committee (FPC)
- Prudential Regulation Authority (PRA)
- Financial Conduct Authority (FCA)
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What is the Financial Policy Commitee (FPC) and what do they do? (5)
- A regulatory body part of the BoE set up after the financial crisis in 2008 to identify monitor and protect against systemic risk
- They are macroprudential regulators meaning they regulate the entire financial sector
- Instruct PRA & FCA in tackling root causes of systemic risk
- Advise Gov: warn about systemic risk, bank bailouts that might be neccesary, economics shocks
- Stress tests: 2 annual tests that measure how the banks would cope in the worst possible senario
- They are macroprudential regulators meaning they regulate the entire financial sector
- Instruct PRA & FCA in tackling root causes of systemic risk
- Advise Gov: warn about systemic risk, bank bailouts that might be neccesary, economics shocks
- Stress tests: 2 annual tests that measure how the banks would cope in the worst possible senario
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What is the Prudential Regulation Authority (PRA) and what do they do? (4)
- A regulatory body part of the BoE set up after the financial crisis in 2008 to maintain and regulate the stabillity of banks (mircoprudential regulators)
- Supervise management of risk
- Setting up industry standards and enforcements
- Specifiying ratios/requirements (Capital ratios, liquidity)
- Supervise management of risk
- Setting up industry standards and enforcements
- Specifiying ratios/requirements (Capital ratios, liquidity)
191
What is the Financial Conduct Authority (FCA) and what do they do?
- They are a government run organisation which aim to protect consumers and increase confidence in financial intitutions (Microprudential) This is done by:
1) Supervising behaviour of firms/markets
2) Promote competition so consumers get better deals
3) Banning financial products against interest of consumers
4) Banning or changing misleading adverts of financial products (reducing information gaps e.g. loan shark interest rates)
1) Supervising behaviour of firms/markets
2) Promote competition so consumers get better deals
3) Banning financial products against interest of consumers
4) Banning or changing misleading adverts of financial products (reducing information gaps e.g. loan shark interest rates)
192
What is meant by financial market failure?
When free functioning financial markets fail to allocate financial products at the socially optimum level of output
193
What are 2 group causes of financial market failure (fundemental reasons)?
- Excessive risk created / overproduction and consumption of higher risk financial assets
- Monopoly pricing, which could involve collusion and fixing interest rates/exchange rates
- Monopoly pricing, which could involve collusion and fixing interest rates/exchange rates
194
What is adverese selection? How can it lead to financial market failure?
For a firm, the most likely consumers to buy their products is who they would least like to sell to due to imperfect information
- For example in the healthcare insurance, premiums will be based on who the firms believe think will buy them
- But healthy consumers (who are the best customers) will think prices are too high and unhealthy consumers (who are the worst customers) will think they are a good deal
- So as a result firms will sell to those unhealthy customers creating excessive risk
- For example in the healthcare insurance, premiums will be based on who the firms believe think will buy them
- But healthy consumers (who are the best customers) will think prices are too high and unhealthy consumers (who are the worst customers) will think they are a good deal
- So as a result firms will sell to those unhealthy customers creating excessive risk
195
What are 3 types of financial market regulation and their intention?
- Maximum interest rates = prevent consumers being exploited and reducing excessively risky loans
- Deregulation = creates higher competiton which will result higher interest on savings and lower interest rates when borrowing, all in the best interest of consumers
- Prevent the sale of unsuitable financial products to consumers = protect consumers from high risk products with limited benefits
- Deregulation = creates higher competiton which will result higher interest on savings and lower interest rates when borrowing, all in the best interest of consumers
- Prevent the sale of unsuitable financial products to consumers = protect consumers from high risk products with limited benefits
196
What are some problems with financial market regulation?
Double A, RU
- Administration & enforcements costs = If these costs are greater than the benefits this may be a cause of government failure
- Asymmetric information/information failure = Banks always have more info than the regulators and hence make it difficult for effective regulations to be imposed
- Regulatory capture = Regulators fall fond of firms that they are regulating which could lead to softer regulations which may be in the worse interest of consumers
- Unintended consequences = Firms may leave if regulation becomes to strict, max interest rates may encourage bad borrowers and reduce lending
- Administration & enforcements costs = If these costs are greater than the benefits this may be a cause of government failure
- Asymmetric information/information failure = Banks always have more info than the regulators and hence make it difficult for effective regulations to be imposed
- Regulatory capture = Regulators fall fond of firms that they are regulating which could lead to softer regulations which may be in the worse interest of consumers
- Unintended consequences = Firms may leave if regulation becomes to strict, max interest rates may encourage bad borrowers and reduce lending
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What are some evaluation points for financial market regulation?
1) Maintain a balance in protecting consumers and reducings systemic risk at the same time ensuring banks remain profitable
2) Regulation should promote effeciency without damaging effeciency = e.g. lack of innovation, reduced competition as a result of regulations
3) Costs vs benefits
2) Regulation should promote effeciency without damaging effeciency = e.g. lack of innovation, reduced competition as a result of regulations
3) Costs vs benefits
198
Explain how the monetary policy tranmission mechanism works (affecting domestic demand)
Say expansionary monetary policy is implemented...
1) Initial decrease in base interest rate reduces market rates, which lowers interest payments on mortgages and rates of return on savings
2) Lower interest rates reduces the cost of borrowing so borrowing increases.
3) a. Demand for mortgages will increase causing house prices to rise
b. Demand for shares will increase as they will offer better returns on savings leading to an increase in share prices
4) A positive wealth effect will be created as a result as consumers feel more wealthy, increasing spending and investment which increases domestic demand (AD shifts right)
5) Demand pull inflation
1) Initial decrease in base interest rate reduces market rates, which lowers interest payments on mortgages and rates of return on savings
2) Lower interest rates reduces the cost of borrowing so borrowing increases.
3) a. Demand for mortgages will increase causing house prices to rise
b. Demand for shares will increase as they will offer better returns on savings leading to an increase in share prices
4) A positive wealth effect will be created as a result as consumers feel more wealthy, increasing spending and investment which increases domestic demand (AD shifts right)
5) Demand pull inflation
199
Explain how the monetary policy tranmission mechanism works (affecting international demand)
Say expansionary monetary policy is implemented....
1) Base interest rate is reduced which will lead to a fall in market rates
2) 'Hot money' outflows = Investors will sell their pounds to buy more lucrative currencies
3) The market supply of pounds will increase and demand will fall, leading to a depreciation in the exchange rate
4) WIDEC = Exports will increase and imports will fall wich will influence X-M and increase AD
5) Demand pull inflation
1) Base interest rate is reduced which will lead to a fall in market rates
2) 'Hot money' outflows = Investors will sell their pounds to buy more lucrative currencies
3) The market supply of pounds will increase and demand will fall, leading to a depreciation in the exchange rate
4) WIDEC = Exports will increase and imports will fall wich will influence X-M and increase AD
5) Demand pull inflation
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How does quantitative easing work?
1) Central bank creates money electronically and puts it on its balance sheet
2) That money is used to buy financial assets (especially bonds in the UK). This is done to give financial institutions & pension funds cash
3) With the BoE buying up bonds and increasing demand for bonds, their prices increase, and the yield reduces
4) Financial institutes will either choose to loan the money (stimulating growth) or invest in corporate bonds or shares
5) This wil increase the price of corporate bonds/shares increasing their price and reducing yield
6) With yields reduced on coporate bonds, the cost of borrowing becomes cheaper which stimulates borrowing spending and investment = Increase AD
2) That money is used to buy financial assets (especially bonds in the UK). This is done to give financial institutions & pension funds cash
3) With the BoE buying up bonds and increasing demand for bonds, their prices increase, and the yield reduces
4) Financial institutes will either choose to loan the money (stimulating growth) or invest in corporate bonds or shares
5) This wil increase the price of corporate bonds/shares increasing their price and reducing yield
6) With yields reduced on coporate bonds, the cost of borrowing becomes cheaper which stimulates borrowing spending and investment = Increase AD
201
How does quantitative easing affect the exchange rate?
In the process of quantitatve easing the supply of pounds increases, leading to a depreciation in the £. This will make imports more expensive reducing import expenditure and exports for foreigners cheaper, increasing export revenue, leading to a right shift in AD.
202
What is the difference between expansionary and contractionary monetary policy?
Expansionary monetary policy involves the central bank reducing the base interest rate in order to increase inflation, AD and reduce unemployment
Contractionary monetary policy involves the central bank increasing the base interest rate in order to decrease inflation, prevent asset bubbles, reduce excess debt and promote savings and reduce the current account deficit
Contractionary monetary policy involves the central bank increasing the base interest rate in order to decrease inflation, prevent asset bubbles, reduce excess debt and promote savings and reduce the current account deficit
203
What are the Bank of England main tools it uses when implementing monetary policy?
- Changing the base interest rate
- Changing the supply of money by affecting the level of credit in the economy
- Changing the exchange rate
- Changing the supply of money by affecting the level of credit in the economy
- Changing the exchange rate
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What are some negatives associated with expansionary monetary policy? (4)
- Demand pull inflation which is above the intended target
- Liquidity trap = Keynsian school of thought argue interest rates have a lower bound and when they hit that lower bound consumers and businesses would have already converted there assets into more liquid assets because of unccertainty in the economy or to spend on goods on services. Therefore cutting interest rates will be ineffective since borrowing is not required.
- Negative impact on savings
- Time lags = aprox 18 month for an interest rate cut to feed through
- Liquidity trap = Keynsian school of thought argue interest rates have a lower bound and when they hit that lower bound consumers and businesses would have already converted there assets into more liquid assets because of unccertainty in the economy or to spend on goods on services. Therefore cutting interest rates will be ineffective since borrowing is not required.
- Negative impact on savings
- Time lags = aprox 18 month for an interest rate cut to feed through
205
What are some evaluation points for expansionary monetary policy?
- Size of the output gap, more effective in a deeper recession
- Consumer & business confidence
- Bank willingness to lend/ pass on the full interest rate cut
- Size of the rate cut. bigger cut more desirable
- Consumer & business confidence
- Bank willingness to lend/ pass on the full interest rate cut
- Size of the rate cut. bigger cut more desirable
206
What are ways that supply side policies can be used to target labour markets?
- Improving education and training which improves the quality of labour
- Reducing income taxes provides an incentive to work, which could lead to an increase in the quantity of labour
- Reducing minimum wages/Trade union power = High minimum wages and strong trade unions fix wages above the equilibrium wage rate, leading to an excess supply for labour. The result of reducing trade union power and minimum wages is that cost are lower for firms, improving their efficiency
- Reducing income taxes provides an incentive to work, which could lead to an increase in the quantity of labour
- Reducing minimum wages/Trade union power = High minimum wages and strong trade unions fix wages above the equilibrium wage rate, leading to an excess supply for labour. The result of reducing trade union power and minimum wages is that cost are lower for firms, improving their efficiency
207
What are the advantages of supply side policies?
- The theory states that all macro economic objectives are achieved
- Stimulates growth from AD & AS
- Sustainable non inflationary growth
- Stimulates growth from AD & AS
- Sustainable non inflationary growth
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What are the disadvantages of supply side policies?
- Very expensive > High opportunity cost
- Takes a long time > Time lags
- No guarantee that they will work
- Will be ineffective with a large amount of spare capacity in the economy > Demand side policies will be more effective in this scenario
- Takes a long time > Time lags
- No guarantee that they will work
- Will be ineffective with a large amount of spare capacity in the economy > Demand side policies will be more effective in this scenario
209
What is the labour force?
Everybody employed + unemployed willing and able to work
210
What is the labour force participation rate?
Labour foce ÷ Population
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Who is considered not in the labour force?
Anyone not looking for a job because they do not want one or has given up in doing so
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How is the unemployment rate calculated?
Ratio of unemployed people to the total number of people in the labour force
213
What is underemployment?
When an existing worker does a job that is not related what they've not specialised in
214
What are the 5 types of unemployment?
Cyclical
Structural
Frictional
Seasonal
Real wage
Structural
Frictional
Seasonal
Real wage
215
What is cyclical unemployment (demand deficient)?
- When there is less demand in the economy (Reduced AD) there is less need for firms to hire labour so workers are fired
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What is frictional unemployment?
This is the time between leaving a job and looking for another job. (search unemployment)
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What is structrural unemployment?
- This occurs with a long term decline in demand for the goods and services in an industry, which costs jobs.
- This type of unemployment is worsened by the geographical and occupational immobility of labour. If workers do not have the transferable skills to move to another industry, or if it is not easy to move somewhere jobs are available, then those facing structural unemployment are likely to remain unemployed in the long run
- This type of unemployment is worsened by the geographical and occupational immobility of labour. If workers do not have the transferable skills to move to another industry, or if it is not easy to move somewhere jobs are available, then those facing structural unemployment are likely to remain unemployed in the long run
218
What is seasonal unemployment?
When demand for labour is dependent on the season e.g. tourism, ice cream vans
219
What is real wage unemployment?
Due to labour market imperfections, we see a higher wage than the equilibrium wage rate, which leads to an excess supply of labour. This excess supply is known as real wage unemployment
220
What is the natural rate of unemployment?
- It is the point where labour demand = supply (the level of unemployment when the economy is at Yfe)
- There will be enough jobs for everyone in the labour force to have a job, but not everyone will be in a job due to frictional and structual unemployment
- There will be enough jobs for everyone in the labour force to have a job, but not everyone will be in a job due to frictional and structual unemployment
221
What is the definition of unemployment?
The proportion of people in an economy's labour force willing and able to work, but cannot find a job despite an active search
222
What are some reasons for structual unemployment?
Automation: New jobs appear due to advancements in technology, but the old jobs disappear forever (creative destruction)
Outsourcing: When a firm shifts its production to another country where labour costs are cheaper, this can cause deindustrialisation and regional depreivation
Outsourcing: When a firm shifts its production to another country where labour costs are cheaper, this can cause deindustrialisation and regional depreivation
223
What are some of the factors that can impact labour mobility?
House prices: If it is expensive to live where jobs are located, this can increase the degree of geographical mobility
Training/Education: Jobs that require higher levels of skills and qualifications will increase the amount of occupational immobility
Training/Education: Jobs that require higher levels of skills and qualifications will increase the amount of occupational immobility
224
What are the impacts that unemployment has on an individual?
- Lowers their standard of living
- Hysteresis: The longer somebody is unemployed the harder it is for them to return to work, leading to demotivation and the loss of their skills
- Hysteresis: The longer somebody is unemployed the harder it is for them to return to work, leading to demotivation and the loss of their skills
225
What are some impacts that unemployment has on an economy?
- Lower tax revenue and higher payouts in benefits
- Low animals spirits and moral, leading to less spending
- Low animals spirits and moral, leading to less spending
226
What is inflation?
The sustained rise in the average price of goods and services over a period of time
227
What are 2 types of inflation you need to be aware of?
Demand pull inflation = AD shifts to the right
Cost push inflation = SRAS shifts to the left
Cost push inflation = SRAS shifts to the left
228
Explain what happens when AD shifts to right causing inflation
When AD shifts to the right, there is greater pressure on existing factors of production to produce more output, because they are becoming more scare closer to FE, so prices increase
229
Explain what happens when SRAS shifts to the left causing price levels to rise
When firms experience an increase in costs of production, these costs are passed on to consumers in the form of higher prices, hence inflation
230
What is deflation?
The persistant fall of prices in an economy in a year, in other words when the inflation rate is negative
231
What are the 2 types of deflation?
Demand side deflation (Bad/Malignant) when AD shifts left
Supply side deflation (Good/Benign) when SRAS shifts right
Supply side deflation (Good/Benign) when SRAS shifts right
232
1) When does long term (anticipated) deflation occur?
2) What are the consequences of this?
2) What are the consequences of this?
1) When AD shifts to the left
2) Deflationary spiral: Delayed spending since rational consumers will wait for prices to fall cheaper reducing spending and hence AD will fall further, reducing growth and employment
Positive real interest rates will mean people save: again reducing AD. e.g. lets say interest rates are at 0% and inflation is -2%. Real interst rates is going to be nominal interest take away inflation.
2) Deflationary spiral: Delayed spending since rational consumers will wait for prices to fall cheaper reducing spending and hence AD will fall further, reducing growth and employment
Positive real interest rates will mean people save: again reducing AD. e.g. lets say interest rates are at 0% and inflation is -2%. Real interst rates is going to be nominal interest take away inflation.
233
What are the negative effects of inflation? (4)
Think 'FCML'
- Fall in real incomes, if not udjusted for inflation (reduced purchasing power)
- Loss of international competitiveness, with a decline in exports due to higher prices
- Creates uncertainty reducing firms willingness to invest
- Makes saving unattractive, increasing spending and further increasing the price level
- Fall in real incomes, if not udjusted for inflation (reduced purchasing power)
- Loss of international competitiveness, with a decline in exports due to higher prices
- Creates uncertainty reducing firms willingness to invest
- Makes saving unattractive, increasing spending and further increasing the price level
234
What is wage push inflation?
This occurs when there is an increase in AD, unemployment falls and with an increased demand for workers the price of workers i.e. there wages increase
235
Explain the term fiscal drag (costs of inflation)
Say you was to get an increase in pay increase that reflects inflation in that year, which brings you into a higher tax bracket.
You are not any better off since your pay was only to match inflation and now you have to pay even more in taxes
You are not any better off since your pay was only to match inflation and now you have to pay even more in taxes
236
What are the benefits of slow and steady inflation?
- Incentivises healthy consumption habbtits, leading to healthy growth
- Workers may see an increase in wages, improving living standards
- Workers may see an increase in wages, improving living standards
237
Wether inflation is good or not depends on (Evaluation ponts)
- The cause
- Duration
- Severity
- Duration
- Severity
238
Draw a short run philips curve and explain what it shows
- The short run philips curve is used to demonstrate the relationship between inflation and unemployment
- With lower rates of unemployment, inflation in the economy is higher, and when unemployment is high, inflation in the economy is lower
239
What is one way that the short run philips curve can be critiqued?
Monetarists argured that the short run philips curve cant be used to show periods where an economy is suffering from high inflation and high unemployment (stagflation)
240
Using diagrams explain how the long run philips curve can be derived
1) Using a classical AD model, assume were are at the NRU there has been an increase in AD
2) This cause inflation to rise and unemployment to fall which we take across to the philips curve
3) When AD shifts right, labour is becoming more scarce, and as a result workers can bargain for higher wages leading to cost push inflation
4) This cause SRAS to shift left, and the economy is back at the NRU
5) From there we can draw a vertical line downwards, representing the long run philips curve
241
Explain how the short run philips curve can shift?
Whenever there is a shift in SRAS, the short run philips curve will shift in the opposite direction
242
Draw a diagram to represent structual unemployment (which also shows the natural rate of unemployment)
243
What policies can be used to reduce cyclical unemployment?
How can these be evaluated?
How can these be evaluated?
Expansionary monetary: Reducing the base interest rate, exchange rate or increasing the money supply can lead AD increasing
Expansionary fiscal: Increasing government spending can lead to AD increasing
- This may conflict with other macro objectives e.g. inflation
- Depends on factors including a) size of the output gap b) size of the multiplier c) business and consumer confidence
Expansionary fiscal: Increasing government spending can lead to AD increasing
- This may conflict with other macro objectives e.g. inflation
- Depends on factors including a) size of the output gap b) size of the multiplier c) business and consumer confidence
244
What are some policies that can reduce frictional unemployment?
How can they be evaluated?
How can they be evaluated?
Reduce unemployment benefits: This disincentives people leaving jobs without having new ones with low benefits
Improve job information: This makes it easier for people who are searching for jobs to get them
BUT, Long time lag, opportunity cost
Improve job information: This makes it easier for people who are searching for jobs to get them
BUT, Long time lag, opportunity cost
245
What are the 3 main factors that determine the NRU?
Labour mobility: The ability for workers to switch jobs
Wage flexibilty: The ability for wages to change with changes to the labour market
Flexibilty of working arrangements: The ability for employers to hire workers in a way that suits them
Wage flexibilty: The ability for wages to change with changes to the labour market
Flexibilty of working arrangements: The ability for employers to hire workers in a way that suits them
246
What are some policies that can reduce the NRU?
Improvements to the flexibilty of the labour market (supply side policies)
- Laws that allow employers to hire workers more freely
- Reducing NWM/Trade union power
- Improving mobility of labour
- Laws that allow employers to hire workers more freely
- Reducing NWM/Trade union power
- Improving mobility of labour
247
What are some policies that can be used to reduce demand pull inflation?
How can they be evaluated?
How can they be evaluated?
Contractionary monetary/fiscal policy (basic chains)
BUT, Growth/unemployment harmed in the process which are key macro objectives
BUT, Growth/unemployment harmed in the process which are key macro objectives
248
What are some policies that can reduce cost push inflation?
How can they be evaluated?
How can they be evaluated?
- Government restricting wage rises to reduce costs of production, BUT this can lead to an inflexible labour market
- Reducing corporation taxes to reduce firms cost BUT government lose out on fiscal dividends
- Subsides BUT can be expensive and can lead to moral hazard
- Reducing corporation taxes to reduce firms cost BUT government lose out on fiscal dividends
- Subsides BUT can be expensive and can lead to moral hazard
249
Describe the govenments main macroeconomic objectives?
250
[Chain of reasoning] Explain via classical AD/LRAS how a deflationary outgap is caused and adjusted
1) If there is a decrease in AD e.g. due to a fall in investment or net exports in the short run output will fall from yfe to y2
2) Firms would rather not accept this new equilibrium as it implies laying of trained skilled workers increasing unemployment in order to reduce costs and remain profitable.
3) They would rather cut wages and keep their workforce in tact reducing their costs of production and returning the economy back to full employment
4) But classical economists argue 3 reasons why wages will not fall in the short run. High unemployment benefits, High minimum wages and High trade union power
5) This would lead to the economy experiencing an deflationary output gap
2) Firms would rather not accept this new equilibrium as it implies laying of trained skilled workers increasing unemployment in order to reduce costs and remain profitable.
3) They would rather cut wages and keep their workforce in tact reducing their costs of production and returning the economy back to full employment
4) But classical economists argue 3 reasons why wages will not fall in the short run. High unemployment benefits, High minimum wages and High trade union power
5) This would lead to the economy experiencing an deflationary output gap
251
[Chain of reasoning] Explain what happens to a deflationary output gap in the long run according to the classical model
- In the long run wages become variable as deflationary pressure and higher unemployment will feed through to lower wages.
- This is because those who are unemployed will revise down their wage expectations to find work and those in work will revise down their wage expectations to stay in work
- This will result reduces firms costs of production shifting SRAS to the right where output returns to full employment with lower inflationary pressure
- Therefore classical economist will argue that output gaps will only exists in the short run as in the long run the economy will self heal and return to the full employment level of output, only with lower levels of inflation
- This is because those who are unemployed will revise down their wage expectations to find work and those in work will revise down their wage expectations to stay in work
- This will result reduces firms costs of production shifting SRAS to the right where output returns to full employment with lower inflationary pressure
- Therefore classical economist will argue that output gaps will only exists in the short run as in the long run the economy will self heal and return to the full employment level of output, only with lower levels of inflation
252
What are some examples of a demand side shock?
- A sudden fall in investment
- A banking/financial crisis: bank crashes can lead to less lending to individuals and firms reducing AD
- A banking/financial crisis: bank crashes can lead to less lending to individuals and firms reducing AD
253
What are some examples of supply side shocks?
- Sudden rise in commodity prices
- A rise in business taxes
- A rise in business taxes
254
Using a diagram explain 'crowding out' impact of fiscal policy
- If expansionary fiscal policy is government spending heavy, it can crowd out private sector investment
- This is because when the government borrow they increase demand for lonable funds increasing their price i.e. interest rates
- With higher interest rates firms will be less willing to take out loans to invest and hence they are crowded out from investing
- This leads to unbalanced economic growth within the economy
255
Explain using a diagram how the liquidity trap can be used to evaluate expansionary monetary policy
- When interest rates are so low, economists assume that individuals would have already converted their iliquid assets into cash
- As a result if the central bank tried to lower interest rates further by increasing the money supply, there would be no effect
