Macro Revision

Question 1

Define inflation.

Answer 1

Inflation measures the annual percentage change in prices.

Question 2

Define adaptive expectations.

Answer 2

Adaptive expectations adjust to inflation on the basis of current and past inflation.

I.e. if inflation is increasing expectations will tend to lag behind the current level depending on how people weight past and present values.

Question 3

Define rational expectations.

Answer 3

This is when all available information is used to anticipate changes in inflation.

With rational agents and unbiased info average expectations equal the actual rate.

Question 4

Name the three main costs of inflation.

Answer 4

Menu costs, shoe leather costs, and income redistribution.

Question 5

Define menu costs.

Answer 5

Costs associated with having to adjust price lists or labels.

Question 6

Define shoe leather costs.

Answer 6

To save on losing interest in a bank people will hold less cash and make more trips to the bank (wearing down the leather on their shoes).

Question 7

Define income redistribution (re: inflation).

Answer 7

Inflation typically makes borrowers better off and lenders worse off (due to nominal repayments being worth less in real terms).

Question 8

There are two high-level causes of inflation, name and define them.

Answer 8

Demand-pull inflation: Inflation caused by persistent rises in aggregate demand.

Cost-push inflation: Inflation caused by persistent rises in costs of production (independent of demand I.e. AD curve fixed).

Question 9

Demand-pull inflation - how does the AD-AS curve change and how do firms react?

Answer 9

AD curves shifts to the right. Firms respond to demand rise with higher prices and and an increase in output.

Question 10

Demand-pull inflation: what determines the degree of price rises?

Answer 10

How much a firms costs rise as a result of increasing output (due to increased demand).

The AS curve tends to become steeper as the economy approaches the peak of the business cycle (actual output nearing peak output).

Question 11

Demand-pull inflation: what is required for inflation to persist?

Answer 11

A continuous rightward shift in the AD curve this continued price rises.

Causes include demand shock or booming economy.

Question 12

Demand-pull inflation: Generally, what happens re: output and employment?

Answer 12

Both rise.

Question 13

Cost-push inflation: What happens to AS curve?

Answer 13

Shifts to the left continuously independent of demand.

Question 14

Coat-push inflation: How do firm costs change and why?

Answer 14

Firm costs rise - partly due to a price rise passed onto consumers and partly by cutting back on supply.

Question 15

Cost-push inflation: What determines how much prices rise?

Answer 15

The shape of the AD curve determines how much prices rise and production is cut back.

An inelastic AD curve means sales fall less due to price rise (steep AD) and more costs passed to consumers. Vice versa for elastic AD.

Question 16

Cost-push inflation: Generally, what happens to output and employment.

Answer 16

Both fall.

Question 17

Can demand-pull and cost-push inflation occur simultaneously?

Answer 17

Yes.

Question 18

How can inflation be handled?

Answer 18

Demand and supply-side policies.

Question 19

Name the two main demand-side policies for tackling inflation.

Answer 19

Fiscal and monetary policy.

Question 20

Summarise fiscal policy.

Answer 20

Fiscal policy targets aggregate spending. The two main methods of fiscal policy are changes in government spending or tax policies.

Question 21

Explain how a fiscal policy of increased government spending could impact the economy?

Provide an example or two.

Answer 21

Increase AD: CIG-XM

Welfare benefits: Increased benefits reduce income inequality and free up income in recipients to feed back into the economy.

Education and training: If successfully targeted, this spending can increase long-term labour productivity and economic growth.

Question 22

Explain how interest rates and quantitative easing are tools of monetary policy.

Answer 22

Interest rates: Higher IR reduce AD and lower inflation maintaining 2% target. Lower IR increase AD via spending and investment to avoid recession.

QE: Decreasing money supply decreases demand helping maintain 2% inflation target. Increasing money supply increases demand and investment to avoid recession.

Question 23

Name the two main supply-side inflation policies.

Answer 23

Free-market supply-side polices and interventionist policies.

Question 24

Summarise free-market supply-side policies.

Answer 24

Involves increasing competition and free-market efficiency.

I.e. privatisation, deregulation, lower income tax rates, and reducing trade union power.

Question 25

Summarise interventionist supply-side policies.

Answer 25

Government intervention to overcome market failure I.e. higher government spending on transport, education, and communications.

Question 26

Define natural unemployment.

Answer 26

The rate of unemployment in labour market equilibrium.

This includes seasonal, frictional, and voluntary unemployment.

Question 27

Summarise seasonal, frictional, and voluntary unemployment.

Answer 27

Seasonal: Unemployment tied with seasonal demand I.e. ski resorts.

Frictional: In between jobs.

Voluntary: Choose not to work.

Question 28

Define structural unemployment.

Answer 28

Unemployment due to a shift in economic activity I.e. demand for printers falls with the internet age.

Question 29

What does a minimum wage do to AD-AS labour equilibrium?

Answer 29

Sets minimum wage above equilibrium level.

Reduces demand for workers as, ceteris paribus, profit falls for firms.

Increases supply of workers as more are willing.

Question 30

Summarise comparative advantage.

Answer 30

When one country can produce a good or service at a lower opportunity cost than another - this results in relatively cheaper goods and specialisation.

Question 31

Summarise absolute advantage.

Answer 31

A country can produce a good or service at lower cost than another country - this consumes fewer resources than competitors to produce the same good or service.

Question 32

Country A can produce either 10m apples or 5m bananas while Country B can produce either 20m apples or 15m bananas.

Describe the situation of absolute or comparative demand and decide who should produce what.

Answer 32

Country B has absolute advantage as it can produce more apples AND bananas.

However, Country B has comparative advantage in bananas as it can produce 3x as many as Country A while it can only produce 2x as many apples.

B should specialise in bananas and leave apples to A.

Question 33

Specialisation is good, but describe the two costs of over-specialisation.

Answer 33

Over-specialisation leaves the economy vulnerable to structural unemployment.

Diminishing marginal returns dictate reduced benefit to ever extra unit of specialisation. It’s unlikely equilibrium is 100% specialisation so there will be water input.

Question 34

Define purchasing power parity (PPP).

Answer 34

PPP is an exchange rate between currencies that equalises the purchasing power of each currency taking into account cost of living and inflation differences.

Question 35

Define discount rate.

Answer 35

Discounting is used to compare costs and benefits in different time periods.

Accounts for inflation of a currency over time.

Question 36

Define rent-seeking behaviour.

Answer 36

Improves the welfare of an individual at the cost of another.

Question 37

Define adverse selection.

Answer 37

The tendency of those at greatest risk to take out insurance.

Question 38

Define moral hazard.

Answer 38

The temptation to take more risk when you know other people (insurance) will cover the risk.