P2 Exam Q ET Flashcards
(39 cards)
Is a large trade deficit a cause of concern
X-M is a components of AD so a deficit shifts AD inwards also imports are a leakage from CFOY= negative multiplier effect and if AD shifts in then economic growth falls and unemployment rises
Eval
-It depends where economy is, if at full capacity and shifts in then not a cause of concern
- Depends as if deficit is caused by a country improving capital machinery and technology then in LR may become net exprter
Evaluate the macroeconomic effects of market failure in the financial sector (25)
Info
-During financial crisis they gave mortgages to anyone even if they can pay it back = increase demand = increased prices and bubble eventually burst
1) The 2008 Financial crash led to a significant collapse in the housing market , the housing market bubble was created through excessive lending and excessive risk taking and it then eventually popped causing house prices to fall leading to a negative wealth effect= decreased consumer confidence = decreased consumption = AD shifts in = decreased economic growth an increased unemployment
Eval
- Bank of England cut base rates from 5% to 0.5% meaning consumers save less and consumption increases and borrowing increases = AD shifts right so negative impact of house prices can be offset by monetary policy
2) Gov spending increased as had to bail out banks = increased fiscal an national deficit which is the accumulation of all fiscal deficits over time. In 2007 debt as a proportion of GDP was around 35% while it increased to 60% in 2009. This decreases the government’s credit rating = decreases demand for bonds= decreases price for bonds and increases IR = increases cost of borrowing for UK gov = harder for them to service future debts
Eval
- Increase in fiscal deficit an national debt may be temporary so robot can o back to monk eg can be corrected by fiscal policy
3) Moral hazard- when banks get bailed out out it becomes an expectation they will get bailed out again
Discuss whether providing substantial government support to bank is the best policy response during a financial crisis (15)
If they allowed banks to fail = savings become worthless = decreased consumer confidence = decreased consumption = AD shifts in = negative economic growth which in LR may lead to depression so it was the best policy as gov needed to bail them out to prevent this
Eval
-However creates moral hazard as banks will have the expectation that if they take on excessive risk the gov will save them which in th long run can lead to another market failure in the financial sector
If several banks collapsed = less banks to borrow from = increase IR = decreased investment and decreased international competitiveness = decreased AD = decreases LRAS in long term also increased price from p1 to p2 which may cause stagflation so have to intervene
Eval
- intervention of gov = increased fiscal and national debt = decrease credit rating of uk gov = decreased demand for bonds an decrease price for bonds = increase IR = hard for firm to service future debts = problem
Macroeconomic = any policy
Gov policy = All but not monetary policy
Loose= expansionary
Tight = contractionary
Evaluate the effectiveness of macoroeconomic policies during covid (25)
Define demand side. During Covid consumer incidence was low = so low confidence and negative implications on economy
1) One policy that could be used to stimulate growth is expansionary monetary policy. During Covid Bank of England cut base rate to 0.1% = decreased savings = increased borrowing as cheaper = increased credit purchases so increased consumption. Also those paying tracker mortgages pay lower mounts each month= increased disposable incomes an increased AD
Additionally lower cost of borrowing= increases investment = increases consumption = both components of AD = Ad shift out. Also investment is n injection into circular flow of income = positive multiplier effect. Multiplier is the number of times the rod in national incomes exceeds the injections that cause it
Shift AD twice from AD1 to AD3 to show multiplier diagram
- this cases economic growth to rise from Y1 to Y3 which could offset the negative impact of covid as consumer onfidence is likely to have been low
Eval
- monetary policy may b ineffective as Bank of England may have suffered from liquidity trap where monetary policy becomes ineffective as further cuts to base rate = little to no impact on economy as commercial banks may be unwilling to cut their IR any lower than they already save cut them. The uk base rate has not been above 1% since march 2009 therefore commercial banks are likely to have already cut their IR as low as they’re willing to do so cutting them further does nothing
2) Expandionary fiscal policy = increased spending on like test and trace system = not jobs also gov pension is components of AD , AD shofboutb and gov spending is an injection = positive multiple effect
Eval
Fiscal deficit increase an around debt so fall in credit rating
Discuss 2 reasons why economic growth is an inadequate measure of changes in living standards between countries
1) GDP doesn’t take into account income inequality it may look good cos of rich ppl
2) undervalued because of subsistence farming = not measure in GDP = low GDP but good
3) hidden economy not measured = undervalued
EVAL
-there’s a positive correlation between GDP and liing standards
- data is easy to collect = easy comparison
Policies to decrease national debt/fiscal deficit
Contractionary fiscal policy , increase taxes eg income or corporation
Eval laffer curve diagram A and B
However for there to be an improvement in the uk fiscal deficit following m increase in tax i i t spend on where the economy is on its laffer curve . If we’re economy wer initially operating at A then increase in tax rate would generate more tax revenue and decrease deficit but if on wrong side at point B then rising taxes results in less tax revenue for gov. If beyond T0 then increased tax avoidance and evasion and brin drain where skilled workers migrate to where no tax rate = less tax revenue
2) decreased gov revenue eg cut transfer payment or benefits = sped less = may the increase productivity as greater opportunity costs of losing your job = shrink deficit
Eval
- however cutting spending decreases structural deficit but is lilet to worsen cyclical deficit as gov spending s part of AD = worse deficit
To what extent is income inequality an essential ingredient to capitalism (10)
Essential as private ownership of assets = geeeate more income from resources = wealth inequality = higher levels of income inequality
Also profit motive = incentive to take risks with setting up business = essential ingredient
Eval
- gov may us pfressive tax system to limit income inequality
- gov can invest in education and training schemes to decrease level I income inequality in long run = decrease gap depite capitalism
In 2020 turkey introduced a tax of 40% . Evaluate economic effects of increased taxes
1) Increase revenue for gov = reduce fiscal deficit and national debt as percentage of GDP= increase credit rating = increase demand for Turkish bonds and price increase = fall in IR= easier to service future debt
Eval
-laffer curve, if at point B then increasing tax worsens deficit as increased brain drain an tax avoidance
2) decreases income inequality = draw Lorenz curve = shifts Lorenz curve in closer to line of equality = gini coeficint falls
Eval
-decrease income = spend less = decrease consumption an increase unemployment and decrease economic growth
Pros and cons of joining monetary union
1) Trade creation
- have same currency as min trading partners
- don hav to worry about unfavourable exchange rate movements negatively squeezing this profit margins = increases confidence = increase investment and counties can to into comparative advantage = can specialise
2) Results in higher levels of FDI, countries want to avoid common external tariff = sett up in eurozone country= increases FDI = investment is a component of AD so AD shift out its lo am injection into CFOY = positive multiplier effect
Draw multiplier diagram
Eval
- loss of monetary independence a only one set IR
- countries become too interdependent
Trade creation
• Have same currency as main trading partners → don’t have to worry about unfavourable exchange rate movements squeezing profit margins.
• Stable currency increases confidence → higher certainty in trade deals → Higher confidence = more investment → firms more willing to expand production and export. Countries can focus on comparative advantage → improves resource allocation efficiency → increased output and lower opportunity cost.
• More trade = ↑X in AD = outward shift in AD → economic growth, lower unemployment.
2) Results in higher levels of FDI
• Countries want to avoid common external tariff → set up in eurozone country instead.
• Increases FDI → investment is component of AD → injection into circular flow of income.
• So AD shifts out → real GDP increases → multiplier effect kicks in.
• Multiplier = 1 / (1 - MPC), so if MPC is high, total rise in national income is much larger than initial injection.
• Leads to lower unemployment and possibly ↑ productivity if investment improves capital stock.
• Higher FDI may also transfer skills, technology → boosts LRAS = long-run growth.
Eval 1: Loss of monetary independence
• Only one central bank sets interest rates → countries lose ability to set IR based on domestic conditions.
• E.g., if one country in recession and needs lower IR, but others are overheating, policy won’t fit all.
• This “one-size-fits-all” policy can worsen output gaps → leads to deeper recessions or overheating.
• Also lose ability to devalue currency → can’t regain competitiveness in current account deficits.
Eval 2: Countries become too interdependent
• Economic shocks can spread quickly (e.g., debt crisis in one member state affects others).
• Countries can’t unilaterally adjust macroeconomic policies → fiscal policy also constrained by rules like deficit limits.
• Interdependence means policy errors in one country can drag others down.
• May create tension between countries, especially if richer states are expected to bail out weaker ones (e.g., Germany and Greece in Eurozone crisis).
Evaluate the effects of the growth of trading blocs such as the TFTA on global trading patterns (25)
1) Growth of trading blocs like Eu is likely to have resulted in trade diversion where trad is diverted away from more efficient producers outside bloc to less effort countires within bloc eg before joining EU, Uk bought majority of butter from New Zealand but when it joined EU it had free trade with France but had common external tariff on New Zealand so pattern of trade hitter from New Zealand to France
^ because ur now part of bloc u can trade freely between countries in bloc but common external tariff on non members so pattern of trade hitter moves to more trade within bloc an less trade outside bloc
Eval
-even with common external tariff countries may still have a comparative advantage so even with tariff an higher cost , pattern of trade shouldn’t be significantly affected as countries will continue to have comparative adv
2) Trade creation = decreased barriers = easier to trade between each other eg Eu hav same currency= increased confidence about trading so pattern of trade shifts to trading within bloc
Eval
How effective trade is spend on how many ontires there are if small then pattern of trade may not be focused within bloc
Exchange rates how can central bank intervene to fix exchange rates
High inflation = less demand for goods = less dumb for currency = depreciates
To devalue = sell pounds and buy foreign currency so supply shifts out
To revalue= buy pounds and sell foreign reserves = demand out
Examine 2 factors that might have caused the depreciation of Ghanas currency (10)
1) increased income = buy more from abroad to do this. = sell currency and buy foreign ret= supply gifts out = depreciates
2) Increased inflation = Ghana less price competitive = decreased demand for Ghanaian goods= decreased demand for Ghanaian currency shifts in = currency depreciates
Eval
If the main trading partners have a even high inflation than Ghana, then Ghana is still relatively price competitive
Evaluate market orientated strategies to promote economic development
1) Promotion of FDI= decrease corporation tax attracts TNCs and investment is a component of AD and it’s also an injection in the circular flow of income therefore causing a positive multiplier effect eg As investment increases, firms expand operations and hire more workers, which means more income which they spend in the economy which increases consumption and increases the demand for goods and services= demand for labour increases= cyclical unemployment decreases = AD shifts out twice = draw multiplier diagram = increases economic growth and increase the standards of living and therefore increases HDI rankings
Eval
-TNCs may exploit workers with low wages and poor working conditions.
• They may outcompete infant industries, limiti
- TNCs cause environmental damage and they take advantage of natural resources
-Smaller domestic firms may be unable to compete → job losses and business closures
^ increase inequality of the Lorenz curve shift out and the Gini coefficient increases
2) Trade liberalisation-decrease barriers like tariffs= trade creation= comparative advantage= They specialise and then there’s a more efficient allocation of resources and they operate outside the PPF and economic development increases as more trade= higher exports =export led growth = increase AD= → ↑Output → ↑Employment → ↑Incomes → ↑Government tax revenue → ↑Spending on healthcare/education → ↑HDI
Eval
However the problem these countries have is their comparative advantage in primary products so are primary product dependent=prebish singer hypothesis = TOT may decline = so they may struggle to import materials and technology
Evaluate interventionist strategies to promote economic development (25)
1) invest in education and training which → ↑Human capital → ↑Labour productivity → ↓Unit labour costs → ↑Competitiveness → ↑Exports & ↑FDI → ↑Employment → ↑Incomes → ↑Consumption → ↑AD
↑Productivity → ↑Output per worker → ↑Tax revenue (income + corporation) → ↑Public services (e.g. health & education)= increase HDI rankings
Eval-
-time lag
-Increased government spending may increase the fiscal and national debt so the credit rating of the gov will fall this will decrease the demand for their bonds and the price of bonds of bonds fall = IR increases = more expensive for government borrow money so harder for the government service future debts
2) protectionism like
↑Tariffs/Quotas → ↓Import competition → ↑Demand for domestic output → ↑Firm revenues → ↑Domestic employment → ↑Incomes → ↑Consumption → ↑AD
↑Jobs → ↑Income tax & ↑Corporate tax → ↑Government revenue → ↑Investment in infrastructure & public services
Eval
- tariff diagram and consumer welfare loss
Judgement
Education is better because increases competitiveness and attract more TNCs where education is high
Discuss 2 macroeconomic policies apart from protectionism that a government can use to reduce negative effects of globalisation
2018
1) invest in education and training= can upskill
Eval time lag
2) decrease corporation tax = more profits and increases innovation= and then increases global competitiveness
Eval
- No guarantee investing profits into R+D
Intervenous policies
- education
- Invest in infrastructure which attracts TNCs= labour is more geographically mobile decreases in income inequality = Lorenz curve shifting in and decrease gini coefficient
Eval
It’s expensive there’s a time lags and the fiscal deficit and national debt may increase which would decrease the gove credit ratings
Discuss the role of the financial sector in the growth and development of developing countries (15)
One role is to facility savings. According to the Harold domar model the savings rate in developing economies tends to be low one of the reasons for this is a lack of banks in these countries to enable individuals to save . As such if banks were to set up in these economies, it would make it easier for individuals to save therefore a higher level of savings would allow banks to lend out more money within a country and high levels of investment is likely to result in more growth and development because investment is a component of AD therefore an increase in investment will shift AD out = it’s also an injection into the circular flow of income therefore it will cause a positive multiplier effect. The multiper is bigger because they are a developing economy super productive capacity increases and LRAS increases.
Eval
However the financial sector is an imperfect solution to this problem this is because the lack of savings is not just caused by a lack of banks but also a lack of incomes
Another way is by providing forward markets as many developing countries like the Ivory Coast or dependent on the export of a primary product such as Cocoa the price of commodities tend to be extremely volatile as they are extremely vulnerable to external shocks like adverse weather conditions and thus the level of investment tends to be low as it’s hard to plan ahead. Forward markets helps with this issue as farmers can in advance agreed to sell the commodity for a fixed price in the future and are guaranteed to receive this price regardless of what happens to the market price this means it’s easier for us to plan ahead and have more confidence therefore the level of investment is likely to arise so the productive capacity of the economy increases economic development increases
Eval
- However education levels are low so workers still low skilled and are not financially literate and if they have the option or forward markets, they may not be able to do it as they don’t know how to or don’t it trust it
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One way is the facilitate savings according to the Harrod domar model many developing countries like Rwanda have very low saving rates. This is problematic as firms struggle to borrow money for investment therefore investments are low. by facilitating savings and making it easier for individuals and firms to save but can now lend out more money to firms which increases investment which is a component of AD so AD shifts out it also injection in CFOY which causes a positive multiply effect which increases economic growth which increases HDI rankings
Evaluate the main constraints that continue to limit economic development in a developing country of your choice (25)
1) primary product dependency. Countries such as the Ivory Coast are heavily reliant on export and sale of primary products such as cocoa 45% of export revenues are from Cocao. Also, 60% of the population work in the agricultural sector. If the price of Cocao falls than many farmers are likely to shut down. This means the government will generate less corporation tax revenue and also the current account may worsen as export earnings will be less
Additionally, if more people around the world want to buy cocoa and AD rises farmers can’t significantly increase production cocoa as price elasticity of supply is inelastic as it takes approximately five years to grow Cocoa so even if the price of cacao is high because of increased demand, they can’t make money as farmers. Also, the volatility of prices makes it harder to plan ahead which decreases investment so there’s low economic development.
Eval
-Some countries doing well by selling primary products for example chile sell copper and are doing well
- take advantage of forward markets where you can agree to sell your commodity for a fixed price in future and are guaranteed to receive that price regardless of what happens to market price at that time which can mitigate the risk so investment may actually increase
Prebish singer hypothesis states that countries the export primary products will be able to import less and less for any given level exports overtime. This is because YED for manufactured goods is greater than that of primary products especially food like cocoa so when incomes rise the demand for manufactured goods will rise more than the primary products and thus relative price of manufactured goods will be higher so countries that export primary products will experience a deterioration in the terms of trade= individuals in the Ivory Coast will have low standards of living as it’s harder to import goods from abroad as they are restricted to buying goods domestically . Also, it’s hard for firms to develop in the manufacturing sector to import capital machinery needed to develop that sector so they become even more primary product dependent.
Eval
- They may have a comparative advantage in production of primary products so they should be specialising in these industries
-Between the 2000 and 2008 the price of primary products were booming while the price of manufactured goods was falling
2) Harrod doma model- savings gap
Economic development is very low due to a lack of savings. If savings are low= low investment= Low capital accumulation= low development
Eval
- May not be significant problem as it used to be as a lot of countries like that Ivory Coast receive higher levels of international aid which can help reduce the saving gap as people don’t need to spend as large of proportion on income on basic necessities meaning it’s easier to save so the saving increases and banks may set up
- Technology makes it easier to save
2) Harrod domar foreign exchange gap- if they like foreign resource and a currency depreciates the terms of trade will fall, so it will be difficult to import capital machinery
-Many countries are in high levels of debt which increases the real value of the debt
Eval
- Tourism means higher foreign reserves
-Debt relief can be used to fill the foreign exchange gap as countries don’t need to spend large amounts of foreign reserves on paying off debts so they can use it to import capital machinery and technology
Examine policies which might improve the competitiveness of the goods and services produced by Greece, Italy, and Portugal (12)
1) investment education and training programs which increases human capital decreases unit labour costs also decrease a structural unemployment and more workers work which increases productive potential and increases by competitiveness also more educated workhorse or more likely to innovate and increase the quality of goods so LRAS shift out
Eval
- Time like and by the time individuals go through education system and gain skills the skills they gain may have become outdated
2) decrease corporation tax= more profits= and invest into R+D some more likely to be innovative also low corporation tax may attract FDI and TNCs may import over their technology or improve infrastructure which increases competitiveness
Eval
-Firms may not invest in research and development as they may pay more dividends to shareholders
-Depends on the state of the economy
Assist the likely effects of the fall and the external value of the cedi on Ghanas economy (12)
Depreciation = more price competitive= exports increase because other countries can now buy more cedi and imports fall it’s gone in currency can’t buy as much in the global market= the car account deficit falls. X-M is a component of AD so AD shifts out, exports are also an injection into the circular flow of income= positive multiply effect.
Multiplier diagram = increases economic growth= decreases unemployment
Eval
However, for there to be an improvement in Ghanas current account following a depreciation of the cedi the marshal lerner condition must be satisfied which states that the average sum of price elasticities of imports and exports must be elastic. Additionally, the Jacob illustrates that the Ghanaian current account deficit is likely to worsen in the short run as firms are tied into trade contracts therefore the marshal Lerner condition is not satisfied so the current account initially gets worse. In the long run contracts can be renegotiated and if the Marshall learner is satisfied, then the car account starts to improve
2) it’s more expensive to import goods so that may cause cost push inflation
Examine two reasons why the Turkish government may want to avoid a significant fall in the exchange rate of the Turkish lira (8) depreciation
One reason to avoid is because it will increase the real value of the debt. When the lira depreciates it means they need to convert more lira to be able to buy £ make it harder for them to service their debts
2) a weak currency makes imports more expensive so the cost of production for Turkish farms increases and SRAS shift in which causes cost push inflation
Eval
However, according to the act inflation peaked so the lira stabilised and the central bank may not need to be concerned about the lira
Market failure in the financial sector
-Bubbles were created due to banks taking on excessive risk that excessive risk led to house prices appreciating in value because they were giving out some prime mortgages (where you give to people that can’t pay) so the bubbles bust= negative wealth effect= decreased consumer confidence = decrease consumption= fall in AD = fall in economic growth and increased unemployment
- Also the gov had to bail out banks which increase the fiscal and national debt so the credit reading fell
- Moral hazard where they take on risk again as banks will help
