PAPER 2 Flashcards
(39 cards)
What is Fiscal Policy
the manipulation of government spending and taxation in order to influence aggregate demand and the level of economic activity
What does contractionary fiscal policy do?
reduce AD.
Why may the government want to do that?
- To reduce inflation
- To reduce budge deficit/national debt (reduce amount of borrowing gov is doing)
- redistribute income
What does expansionary fiscal policy do?
Increases AD.
Why may the government want to do that?
- Boosts Economic growth
- Reduces Unemployment (Firms will be producing more)
- Increase inflation (demand-pull inflation)
What are some examples of expansionary fiscal policy?
- Reduction in income tax
increases disposable income per household, more ad. - Reduction in corporate tax
increases profit margins, corporations could invest which would shift ad out. - Increase in government spending
- health care, education etc.
How can expansionary fiscal policy (reduction of income tax) grow LRAS?
- Reduction in income tax
- This would make the inactive, (outside labour force) to become incentivised to become active increasing quantity of labour boosting LRAS.
- More of an incentive to produce more and work harder as they can keep more of the money.
Diagram showing effect of expansionary fiscal policy, with explanation
https://ibb.co/KGf851G
increases AD and leads to higher real GDP and inflation.
What is monetary policy?
changes to interest rates, money supply and the exchange rate by the central bank in order to influence AD.
What is the aim of monetary policy?
keep inflation low
and
Stable economic growth. (keeps unemployment low)
What’s the UKs target for inflation and why is it important?
2% CPI.
important factor in enabling higher investment in the long-term
What does contractionary monetary policy do?
Decreases AD.
Why may the government want to do that?
- Reduce inflation
- Reduce excess debt & promote saving
What does expansionary monetary policy do?
Increase AD.
Why may the government want to do that?
- Increase inflation
- Increase growth
- Reduce unemployment
What does expansionary monetary policy transmission mechanism do?
- Lower credit card interest rates.
- Lower borrowing costs for consumers, makes it cheaper to borrow, which incentivise more borrowing and less saving, increases marginal propensity to consume meaning consumers will be spending money on big ticket items like cars, furniture, jewellery therefore ad increases as consumption rises. - Weaker exchange rate
Savers have less of an incentive to save, therefore they look to move money out of the country. And a weak exchange rate would lead to an increase in net exports. - Mortgage rates would decrease
this would mean people would have more disposible income leading to more consumption.
What are some causes of unemployment?
Demand deficient
- High interest rates
- global recession
- negative mutiliplier effect
- finanical crissis
Supply Side
- Frictional
- Structural - mismatch of skills
- Geographical immobility
- real wage unemployment
- technological change
What are some economy costs of unemployment?
- Lost Output
- Deterioration of gov finances
Spending on benefits go up, lower tax revenue (income tax), increase gov spending on areas which suffer from higher unemployment. higher crime rates etc. - Social Costs
High levels of crime, high levels of divorces which brings stress, depression for nhs - Reduced trade in other countries
What are some individual costs of unemployment?
- Loss of income
reduced spending, high level of spending - Loss of status
What are some benefits of unemployment?
- Firms benefit from a greater choice of workers
- Workers have time to search for the best job for them
What is deflation?
The persistent fall of prices in an economy in a year
What are the consequences of deflation?
Demand side
- Delayed spending
- Positive real interest rates
- Increases real value of debt
Supply Side
- Falling prices for consumers
- Falling input prices for firms
Good/Bad based on if:
Anticipated or unanticipated
When does protectionism occur?
when countries place restrictions on imports into the economy.
what are some different types of protectionism
Tariffs – This is a tax on imports.
Quotas – This is a physical limit on the quantity of imports
Embargoes – This is a total ban on a good, this may be done to stop dangerous substances
Subsidies – If a govt subsidises domestic production this gives them an unfair advantage over competitors. This is quite common
What are some benefits of protectionism?
Infant industry argument – protect new industries against free trade. Protectionism can enable some industries to survive.
Diversify the economy – tariffs and protectionism can help develop new industries to give more diversification to the economy
Raise revenue for the government.
Protect certain key industries from international competition to try and safeguard jobs.
What are the potential costs of protectionism?
- Protectionism leads to retaliation and therefore higher import prices and higher consumer prices.
- Consumers will have to pay higher prices for imports of goods (e.g. electronic goods from China, food from Africa)
-Higher prices lead to lower overall demand causing job losses in other industries
-Exporters will see a fall in demand, causing less output and possibly unemployment
-Protectionism can encourage inefficient firms to stay in business and there is less scope for specialisation and economies of scale.
-Protectionism can keep smaller national firms which can’t benefit from the same economies of scale. There is less competitive pressure for firms and economies to cut costs.
Diagram of tariff protectionism
https://www.economicshelp.org/wp-content/uploads/2008/01/effect-of-tariffs.png
Losers from tariffs
- Domestic consumers who pay higher prices (P1 to P2). There is a lost consumer surplus of areas (1+2+3+4)
- Foreign exporting firms. Exports fall from (Q4-Q1) to (Q3-Q2)
- Domestic exporting firms hit by retaliatory tariffs (not shown in above diagram)
-There is a net welfare loss to the domestic economy of (2+4)
-Other firms in the economy who see lower demand. Because prices rise for this good, consumers have less disposable income to spend on other goods. Therefore, other firms see a decline in demand.
Winners from Tariffs
- Government gains tariff revenue of area (3)
- Domestic producers who are able to sell a higher quantity to the domestic market. Domestic supply increases from Q1 to Q2. There is an increase in producer surplus of area (1)
How does trade promote growth and development?
- Exploit comparative advantage (natural resources)
exports go up, AD goes up, Growth increases, development increases - Consumers benefit from lower prices
Increases choice and improved political relations (grow trade ties) - Economies of scale and efficiency benefits
Increasing output lowering costs, profits increase, corporate tax revenue increases, more money for development - Technological transfer and growth of secondary industry.
