P2 Stuff Flashcards
(11 cards)
Info
Exchange rates
High inflation= Uk good are less price competitive = demand for british goods decreases = less demand for pound = demand shifts in = causes currency to depreciate
Or more people selling pounds ie exchanging them for other currencies = more sellers = supply shifts out = currency depreciates
Want to devalue pound
-sell pounds, buy foreign reserves, supply shifts out
Re- value
-buy pounds, sell foreign reserves
If bank increases IR = increases demand for pound = demand shift out = revalue
devalue= decrease IR = hot money flows out
Explain how central bank intervene in currency to prevent excessive appreciation or depreciation (5)
In extract pound has depreciated = central bank will want to revalue currency, can do this by buying pounds and selling foreign reserves, so demand shift out
Examine 2 reasons why the turkish gov may want to avoid a significant fall in the exchange rate of the turkish lira
(8)
One reason why the gov may want to avoid a significant depreciation of the lira is because it will increase the real value of their debt. This would make it more difficult for the turkish gov to service their debt as they would need to convert more lira to purchase one dollar.
If lira depreciates= imports now more expensive= SRAS shifts left = cost-push inflation
Access the possible effects of a fall in the external value of the rupee on the indian economy
One impact of the depreciation in the rupee is that it helps to improve indias current account deficit as it makes them more price competitive, demand for exports increases because now other currencies can buy more rupees, and imports are likely to fall because the rupee doesnnt buy as much in global market. If current account improves, AD shifts out,also exports are a injection into the circular flow of income= positive multiplier effect,
Diagram with AD shifting right = economic growth increases = unemployment decreases
Marshal lerner:
For their to be an improvement in indas current account following the depreciation of the rupee, the marshal lerner condition must be satisfied, this states that the average sum of price elasticity of imports and exports must be elastic
Then J curve:
However export and imports are relatively inelastic in the SR as firms are in contracts and cannot significantly increase how much they export or cannot decrease how much they import, so in SR current account gets worse, but in LR the contracts are negotiated and current account gets better in LR
Is a large trade deficit a cause of concern
X-M is a component of AD therefore a deficit = AD shifts in , also import = leakage from CFOY so can lead to negative multiplier effect so if AD falls =economic growth falls = increased unemployment
- Depends on where economy is if full capacity and shift in= not concern
EVAL- If theres economic growth in economy= more demand for imports = not concern
- Persistent deficit = structural weakness in economy eg inflation is too high or low or living standards ar below compared to other countries
EVAL- depends as if deficit is caused by a country importing capital machinery and technology= they will in LR become net exporter
Evaluate the impact of a rising national debt on an economy (10)
National debt refers to the accumulation of all unpaid fiscal deficits up to that point in time. A fiscal deficit is when government spending is greater than government tax revenue in one year.
If debt increases, this will decrease the credit rating of the government,reducing investor confidence, meaning that the demand for its bonds will decrease; therefore, the price of the bonds will fall, leading to an increase in interest rates on the bond. This will make it harder for the government to pay off and service its debt, so more tax revenue will be allocated to interest payments rather than public services. However, some countries like Japan sustain high debt without defaulting. Even though credit rating falls, as long as demand for UK bonds remains high, price will remain high and interest rates will be low; therefore negative impact may be limited. Also depends on how much IR increases
Secondly, increased government borrowing may lead to crowding out, where higher demand for money, raises the price of money and therefore raises interest rates, discouraging private sector investment. If businesses face higher borrowing costs, investment in capital and innovation may fall, leading to slower economic growth.However, if confidence in the economy is already low, private sector investment may already be weak,
Furthermore, a liquidity trap may limit the negative effects of rising debt. In a liquidity trap, even with high government borrowing, interest rates do not rise, and inflation remains low because businesses and consumers prefer to hold cash rather than spend or invest. As a result, despite high debt levels, borrowing costs for the government may stay low, reducing the risks
Explain how quantitative easing works and evaluate its effectiveness in stimulating economic growth (12)
Quantitative easing is when governments buy bonds; therefore, demand for bonds increases and so does the price of bonds; therefore, IR falls from IR1 to IR2 and money supply increases
- Increased money supply: MS1 shifts from MS1 to MS2 and increases money supply from Q1 to Q2, and IR falls from IR1 to IR2 as banks are now more willing to lend due to having increased money supply. This means consumers will be able to take out more from banks, and so will investors. Investment and consumption increases. As a result, it will shift AD to the right, therefore increasing economic growth and decreasing unemployment
QE leads to higher prices for bonds and other financial assets, such as stocks, which create a positive wealth effect, as asset holders feel wealthier, potentially increasing their confidence and therefore consumption and spending
However, if consumer and business confidence remains low, even with lower interest rates and more money in the economy, QE may not stimulate enough spending or investment. If businesses are unwilling to invest, or consumers are unwilling to spend, QE may not have a significant impact on economic growth.
There’s also no guarantee that high bond prices will increase consumption as confidence can still remain low
Evaluate Supply-Side Policies to Stimulate Economic Growth (15 marks)
Supply-side policies aim to improve the long run productive potential of the economy.
One important supply-side policy is investment in education and training. By improving the skills of the workforce, this policy helps increase productivity. Workers who are better trained and more skilled can perform tasks more efficiently, which helps businesses reduce costs and improve output. For example, a more skilled workforce can adopt new technologies or work more productively, contributing to higher overall economic output. This increase in productivity leads to a rightward shift in the LRAS curve, meaning the economy can produce more
However, It can take years before individuals complete their education or training and enter the workforce with new skills. This delay means the policy’s impact on economic growth might not be immediate. Furthermore, funding education and training requires significant government spending. If the government needs to borrow money to fund these initiatives, it could lead to higher national debt, which may cause problems for future government spending.
Another important supply-side policy is investment in infrastructure, which includes things like transport, energy, and communication systems. Better infrastructure reduces the costs for businesses, as it improves the efficiency of transportation and communication. For example, faster and more reliable transport links make it easier and cheaper for companies to get their goods to markets, which increases productivity and lowers prices. Investment in infrastructure also boosts employment, which leads to increased disposable income and consumption and, therefore increased demand in the economy. Over time, this can contribute to higher economic output and improved living standards.
However, infrastructure projects infrastructure projects take time to complete, so the economic benefits may not be felt immediately. In the short term, there’s also an opportunity cost—the government may have to divert money away from other areas, like healthcare or education, to fund infrastructure projects, which could affect overall well-being.
Evaluate strategies that could be used to correct a trade/current account deficit (25)
One way in which Brazil can reduce their trade deficit is by devaluing the real.They do this by selling real and buying foreign reserves. Selling real means that there will be more sellers, so supply will shift right from S to S1. If the currency has devalued, this will make Brazil more price competitive, and their exports will increase because other currencies can buy more real and imports will decrease because the real won’t be able to buy as much in the global market; therefore, the currency account deficit will fall.
For their to be an improvement in Brazil’s current account, following the devaluation of the real, the Marshall-Lerner condition states that the average sum of the price elasticities of imports and exports must be elastic for the current account to improve. If demand for exports and imports is inelastic, then devaluation may not lead to an improvement in the current account.
However, the J curve states that in the short term, demand for imports and exports tends to be inelastic as firms are in contracts and cannot significantly increase how much they export or decrease how much they import. Therefore, after a devaluation, the current account tends to get worse before it gets better. However, over time, demand becomes more price elastic, and the current account improves as contracts are now negotiated.
Another way to reduce Brazil’s trade deficit is by using supply-side policies. One example would be investing in education and training. This would increase the productivity of the workforce, leading to a rise in human capital. As the workforce becomes more skilled, the cost of producing goods and services would decrease, so labor unit costs will fall. Lower unit costs can make Brazilian goods more competitive in the global market, as they can be offered at more attractive prices without sacrificing quality.
A more educated and skilled workforce could also lead to greater technological advancements and innovations, enabling Brazilian businesses to create better products or improve production processes. These improvements could enhance Brazil’s export capacity and product quality, thus attracting more foreign customers. This shift toward higher productivity and more competitive goods would likely lead to an increase in exports, while the improved quality and pricing could reduce Brazil’s reliance on imports, which in turn would contribute to a reduction in the current account deficit.
As productivity rises, Brazil’s economy can produce more at every price level, shifting the LRAS curve rightward from LRAS1 to LRAS2. This shift would lead to a decrease in the general price level (from PL1 to PL2) and an increase in real GDP (from Y1 to Y2). As the economy grows, the current account balance could improve due to higher exports and lower imports, contributing to the reduction of the trade deficit. The overall economic growth would further enhance Brazil’s competitiveness in the global market, improving both the quality and price of its exports.
However, if the government is spending more money to fund investments in education and training, the fiscal deficit will increase and national debt will rise. This could lead to a downgrade in Brazil’s credit rating, which would reduce demand for government bonds, causing bond prices to fall and interest rates to rise. As a result, higher interest rates could make borrowing more expensive, potentially crowding out private investment and reducing business competitiveness. This could limit Brazil’s ability to increase exports, worsening the current account deficit in the short term
Access the possible effects of a rise in the external value of the rupee on the Indian economy
Appreciation
One impact of the appreciation in the rupee is that it may worsen India’s current account balance. A stronger rupee makes Indian exports more expensive for foreign buyers, reducing demand for exports. Simultaneously, imports become cheaper for Indian consumers and firms, leading to a rise in import spending. This can increase the current account deficit.
If net exports fall, aggregate demand (AD) may shift inwards (leftward), as net exports are a component of AD. This reduces the circular flow of income, as imports are withdrawals resulting in a negative multiplier effect, lower real GDP growth, and potentially higher unemployment.
Diagram with AD shifting left = slower economic growth = unemployment increases
⸻
Marshall-Lerner Condition:
For appreciation to worsen the current account, the price elasticity of demand for imports and exports must be elastic. If demand is inelastic, the quantity changes might not offset the price change, and the current account could remain unchanged or even improve.
⸻
J-Curve Effect:
In the short run (SR), export and import demand tends to be inelastic due to contracts and adjustment lags. So, even though imports get cheaper and exports more expensive, the quantity demanded may not adjust quickly—possibly improving the current account briefly. However, in the long run (LR), firms and consumers adjust, demand becomes more elastic, and the trade balance may worsen as import volumes rise and export volumes fall.
Evaluate the macroecomicb effects of higher interest rates in Uk (25)
Define monetary policy
One effect is lower inflation. Higher IR= increased saving= decreased consumption= cost of borrowing is higher=less likely to take out loans = fall in cosumption. Interest on variable mortgages increases so consumption falls
Higher IR = fall in investment as more expensive. Both consumption and investment are components of AD so it falls = disinflation = help to bring closer to inflation target
Eval
-depends on LRAS curve eg at full capacity is good if not then negative growth
Hot money flows in uk as higher rate of return = sell currency and buy pounds = increases demand for pounds = pound appreciates= less price competitive = decreased exports and imports rise = worsens current account deficit
Eval
—marshal letner states average sum of elasticity needs to be elastic for it to worsen
- j curve - gets better then gets worse
