Theme 2 Flashcards
1
Q
What is the Phillips curve principle?
A
An inverse relationship between rates of unemployment and corresponding rates of inflation. (Wage inflation) as closer to full capacity.
2
Q
What is economic growth?
A
Economic growth is defined as the increase in the real value of goods and services produced as measured by the annual percentage change in real Gross Domestic Product (GDP).
3
Q
What is a monetary policy?
A
Monetary policy involves the use of interest rates, exchange rates and changes to the money supply to achieve relevant economic objectives.
4
Q
What is fiscal policy?
A
A government’s policy regarding taxation and public spending. It can be loose (with the emphasis on increased spending and lower tax revenue to boost economic activity, with the acceptance of a wider fiscal deficit) or tight (with the emphasis on cutting spending and raising extra tax revenue, resulting in a slower-growing economy.
5
Q
What factors you need to consider about high unemployment?
Not directly in exam
A
- Loss of income - The majority of the unemployed experience a decline in their living standards and are worse off out of work. This leads to a decline in spending power and the rise of falling into debt problems.
- Negative multipler effect
- Loss of national output
- Fiscal costs - The government loses out because of a fall in tax revenues and higher spending on welfare payments for families with people out of work. The result can be an increase in the budget deficit which then increases the risk that the government will have to raise taxation or scale back plans for public spending on public and merit goods.
6
Q
The benefit of using GDP to make comparisons between countries?
A
is that it shows the size of and how an economy is performing
7
Q
Why GDP per capita is a more suitable indicator to make comparison?
A
as its easier to compare as the population of a country is taken into account
8
Q
What to consider if GDP is being used as a measure?
A
- Shadow Economy
- Quality (innovation and improvements)
- Value of unpaid work
- Regional variations in income and spending and employment
- Inequalities
- Life expectancy
9
Q
What is purchasing power parity?
A
Is an economic theory that compares different currencies of different countries through a basket of goods approach.
10
Q
What is the (Fiscal) Budget deficit?
A
The difference between what the government receives in revenue and what is spends.
11
Q
What is a nominal number?
A
A current price or unadjusted rate, without taking inflation or other factors into account
12
Q
What is a real number?
A
Data is adjusted for general price level changes over time (constant prices are real numbers)
13
Q
What is GDP?
2 ways to calculate it…
A
GDP is the sum market value of all the goods and services produced in one economy in one year*. It can be calculated either by finding the sum value of the economy’s income, or the sum value of the economy’s expenditure
14
Q
GDP per capita equation?
A
GDP / Total population
15
Q
What is a weighted index?
example…
A
A weighted index is an ‘average’ index, made up of a combination of other indices.
price index
human development index
16
Q
What is GNI?
A
Gross National Income (GNI): This is similar to GDP but includes the income received from abroad, for example from dividends from shares owned in foreign companies.
17
Q
What is GNP?
A
Gross National Product (GNP): This is GNI but excludes the income non-nationals claim. It is also the statistic the World Bank uses.
18
Q
What is purchasing power parity?
means we can…
A
Purchasing power parity means that when the ‘buying ability’ of different currencies is equal across countries (through basket of goods approach)
Generalise differences in living standards between nations.
Under or over-valued
19
Q
Whats an index number?
What is it compared to and what is that thing that you compare it with?
A
A useful way of expressing economic data time series and comparing / contrasting information.
Is the figure reflecting price or quantity compared with a base value (always has an index number of 100) - Index number expressed as 100x the ratio to the base value.
20
Q
Limitations of using GDP to compare living standards?
A
- accuracy of statistics… constantly changing population
- shadow economy not included
- negative externalities
21
Q
What is unemployment?
A
the number of people looking for work but who cannot find a job at a point in time.
22
Q
What is the labour force?
A
includes all those who are economically active. i.e. willing and able to work.
23
Q
There are two ways to measure unemployment. What are they?
Not directly in exam
A
Claimant Court - number of people claiming job seekers allowance
Labour Force Survey - quarterly survey of approximately 60,000 households compiled by the office of national statistics.
24
Q
The Gross National Happiness (GNH)?
A
The Gross National Happiness (GNH) Index attempts to steer policy objectives towards development and living standards by measuring happiness rather than production and incomes.
25
Why is Economic Growth a Measure of Economic Performance?
What a well-performing shows.
Brings...
Linked to...
A well-performing economy increases, expands and grows. Economic growth can bring with it more jobs, which will help to lower unemployment and provide an income for people. Economic growth is generally linked to higher living standards and brings greater opportunity to an economy, although this is not always the case.
26
What is underemployment?
Occurs when workers can not find a job that is suitable for their qualifications and experience or who cannot find enough hours to work.
27
What is inflation?
| Not directly in exam
Inflation: a sustained rise in the general price level
28
What is deflation?
| Not directly in exam
Deflation: a sustained fall in the general price level
29
What is disinflation?
| Not directly in exam
Disinflation: a fall in inflation, i.e. a fall in the increase of the general price level
30
What is hyperinflation?
| Not directly in exam
A period of very high rates of inflation, usually leading to a loss of confidence in an economy's currency.
31
Why does a reduction in interest rates cause inflation?
* Households increases consumption as borrowing is cheaper and saving is less attractive.
* Firms struggle to match demand of close to full capacity, may lead to a positive output gap.
* Leads to an increase in the price of goods as firms raise prices to cope with increase cost of employing more workers and buying other imputs
32
What are the three causes of inflation?
* Reduction in interest rates
* Lack of suitably skilled staff
* Depreciation in the exchange rate
33
Why does a lack of suitably skilled staff cause inflation?
| Not directly in exam
• Leads to an increase in costs, as staff are less productive and specialised. Causing cost-push inflation.
• Need to train staff - increase costs to the firm
- prices rise as firms maintain profit margins
• Competition to attract workers - offer higher wages
34
Why does a depreciation in the exchange rate cause inflation?
• Imports more expensive, increase of prices as imports are more expensive
- Costs to firms will rise if they import raw materials
- Prices rise from profit margins and AS shifts left.
- Exports cheaper, As shifts right, demand-pull inflation
35
How inflation is measured?
| Not directly in exam
Consumer Price index - is an index of which includes products of the highest demand (700). Where you compare the average prices of all these products per annum. Sample of 1000 households on what they buy. Weighted.
36
Problem with CPI?
| Not directly in exam
CPI doesn’t include quality or any description/in depth information on it. Aswell, can’t fully explain why there has been charges in the general price level or inflation.
37
What factors you need to consider about high inflation?
| Not directly in exam
1. Income redistribution - it has a regressive effect on lower-income families and older vulnerable citizens who might be living on a fixed income. If prices are rising faster than wages, then there will be a steep decline in real incomes.
2. Negative real interest rates - If interest rates on savings accounts in banks are lower than the rate of inflation, then people who rely on interest from their savings will be poorer.
3. Increased cost of borrowing - as financial markets seek to protect themselves against rising prices and increase the cost of borrowing on short and longer-term debt.
4. Government spending - government to increase the value of the state pension and unemployment benefits and other welfare payments as the cost of living climbs higher.
5. Business confidence
6. Business competitiveness
38
Unit labour costs?
Reflect total labour costs, including social security and employers' pension contributions, and including the costs of self-employed labour, incurred in the production of a unit of economic output.
39
What are the causes of deflation?
| Not directly in exam
1. Holding back on spending - consumers may postpone demand if they expect prices to fall in the future,
2. Debt increases - the real value of debt rises it and higher real debts can be a big drag on consumer confidence.
3. Real cost of borrowing increases - real interest rates will rise if nominal rates of interest do not fall in line with prices
4. Lower profit margins - lower prices can mean reduced revenues and profits for businesses - this can the lead to higher unemployment as firms seek to reduce costs by shedding labour
...
40
The acronym for exhange rates?
```
SPICED
Strong
Pound
Imports
Cheap
Exports
Dear
```
41
What is aggregate supply?
Is the quantity of goods and services that producers in an economy are willing and able to supply at a given level of prices.
42
What is short run aggregate supply related to?
| main factor causing a shift in SRAS
relationship between planned national output and the general price level
the resource cost of producing goods and services e.g. unit wage costs
43
Frictional Unemployment?
| Not directly in exam
While people change from one job to another there is a period of unemployment; this is frictional unemployment. It refers to people who are ‘between jobs’
44
Seasonal Unemployment?
| Not directly in exam
Workers in tourist-reliant industries tend to suffer from seasonal unemployment. Workers in seasonal jobs will find they are out of work during certain periods. Generally, seasonal unemployment is low in summer and high in winter.
45
Structural unemployment is?
| Not directly in exam
Caused by a mismatch of skills between the unemployed and available jobs. Structural unemployed is caused by changes in the economy, such as deindustrialisation, which leaves some unemployed workers unable to find work in new industries with different skill requirements.
46
Cyclical unemployment?
| Not directly in exam
In order to cut back on production and reduce costs, firms will reduce of resources they use; one of these resources is labour, i.e. people will lose their jobs and the level of unemployment will rise. This is likely to occur whenever demand falls, whether in a recession or not, because firms will restrict supply by making resources redundant (such as labour) in order to meet the lower demand levels.
47
Factor Immobility?
Factor Immobility: The inability of factors of production to change or move
48
Geographical Immobility?
Geographical Immobility: the inability of resources to move geographically
49
Occupation Immobility?
Occupation Immobility: the inability of resources to swap from one industry to another
50
What is the current account?
| Not directly in exam
Trade in goods
Trade in services
Investment income
Transfers
51
What is the financial account ?
| Not directly in exam
Transactions in financial assets
Investment flows
Government transactions
52
What is the capital account
| Not directly in exam
Transfer of assets by individuals
53
What is the balance of payments?
| Not directly in exam
A record of a country's trade / transaction with the rest of the world. (three sections - current,financial,capital)
54
Whats a surplus?
A surplus is when the sum of exports of goods,services,investment income and transfers is greater than imports
55
Whats a deficit?
when the sum of exports of goods,services,investment income and transfers is less than imports.
56
What has the UK traditionally run?
What are the reasons?
(Not directly in exam)
A large deficit on the trade in goods component of the current account.
> An increase in the demand for consumer goods, many of which have to be imported
> Decline in the UK manufacturing sector as secondary production is outsourced to low wage economies
> Lower production of primary materials such as gas and oil (UK now imports significant quantities of primary materials from other countries)
> A strong currency makes imports of goods more affordable and exports less attractive to foreign buyers
57
What has the UK traditionally run in the trade in services?
| the two reasons?
Large surplus on the trade in services (component of current account)
> The UK has seen a shift away from primary and secondary sectors towards tertiary employment, this specialising in the provision of services
> This specialisation has meant that the UK is more competitive in the provision of these services, and can offer better services at lower cost. e.g. londons financial centres.
58
What is investment income?
Is generated by UK owned overseas assets. Include profits and dividends that are recieved from abroad and sent back to the UK, and count as a credit item of investment income on the current account. However debit items also occur as foreign investments into the UK may yield profits which are sent back to the country of investment.
59
What are the 2 demand side causes of a current account deficit?
As consumer spending increases so does our demand for goods. In the UK we have a high propensity to consume imported goods thus strong domestic growth (D) leading to consumer spending feeds through to an increased and persistent deficit.
It is also argued that our exchange rate is too strong (D), which makes our exports less competitive and makes imports relatively more affordable.
60
What are the 2 supply side causes of a current account deficit?
In terms of manufacturing, UK firms tend to have lower productivity (s), UK firms have become less competitive in the manufacture of goods and are unable to compete with other (some low wage) economies, and so globalisation has increased and widened, so has the UK's reliance on imported goods.
the deficit is also a sign of an unbalanced economy. Lack of investment (S) in both primary and secondary business activity is shrinking over time, compared with significant growth in the tertiary sector.
61
What inflation does to the current account deficit?
Inflation stimulates import spending, given that imports appear relatively cheaper, and dampens export sales, as exports appear more expensive abroad.
62
Keynesian Long Run Aggregate supply diagram?
No SRAS/LRAS distinction
Economy can produce at < Y full employment
Low output - spare capacity
Horizontal then eventually turns into a sloping vertical until vertical (LRAS)
63
Classical Long Run Aggregate supply diagram?
Markets always revert to the equilibrium
Long run - economy always produces at the full employment level.
Vertical LRAS curve (PPF)
64
What is aggregate demand?
```
The total demand for all goods and services in an economy at any given price level over a period of time.
Consumption C
Investment I
Government spending G
Net exports (exports-imports) (x-m)
```
65
What is real national output?
is the economy taking into account inflation.
66
the shifts and movements in AD?
A change in general price level leads to a movement along the AD curve Contraction or expansion
Shifts in the AD curve will occur if any of the components are changed. Shifts...
67
What are savings?
Disposable income not spent on goods and services
- disposable income includes benefits, excludes income tax and NIC.
Marginal propensity to consume is positive
< 1 = savings
High savings ratio = low consumption low AD
68
What do interest rates do to consumption?
Lower interest rates will normally increase consumption as saving becomes less attractive, loans become more attractive and individuals with variable rate mortgages see monthly disposable income increase.
69
What is disposable income and what happens with consumption?
= household income after taxes + benefits
- Higher levels of disposable income will usually lead to higher levels of consumption as individuals can afford more.
Change depending on tax or wage rates.
70
What consumption is affected by?
```
- Disposable income
Interest rates
Levels of personal debt
Levels of personal wealth
Expectations and sentiments (confidence)
```
71
Macro economic importance of saving?
Business survival /- in recession and takeovers
Further investment /- savings flow into pension funds - used to further investment. Need deposits from which they can lend.
Buffer for consumers /- allow people to reduce debts and not be subject to more borrowing. retirement income
72
What is marginal propensity to consume?
How likely an individual is to consume or save an extra £1 of income they receive.
73
What are the determinants (factors) for saving?
Interest rates - higher interest rates increase the incentive to save some as a reward is greater.
Confidence - if individuals and workers are nervous about their future - be more inclined to save.
Inflation - if prices are rising quickly, then the real savings is eroded, so the incentive to save reduces
74
What is gross investment?
Is spending on capital assets such as buildings, machinery and equipment. - increasing productive capacity of an economy.
75
What is net investment?
gross investment less depreciation and replacement costs.
76
Investment is economy is made up of...
| firms aim to improve...
Private and public investment
| Quantity, quality and efficiency
77
```
What are the key factors in determining investment
growth...
confidence...
demand...
interest and credit...
governemt...
```
1. Rate of economic growth - higher = sooner capital equipment will be needed or replaced
2. Business expectations and confidence ( high or low) - future economic prospects = increased consumption - likely to invest and increase productive capacity.
3. Demand for exports - encourage firms to increase capacity to meet demand
4. Interest rates and access to credit - low interest rates make investment projects less costly and help to stimulate investment. rely on financial institutions to provide access to liquidity.
5. Influence of government and regulations - take advantage of government grants - reducing rules - easier for firms to invest in capital assets.
78
Evaluation points of investment?
- Some of the investment capital goods brought in may be imported - a leakage from circular flow
- May be a time lag for workers having to adjust to new equipment and capital (productivity...)
- some capital investment replaces labour therefore might cause short term unemployment
- many factors affect competitiveness -including the level of the exchange rate.
79
What is government spending?
| Why they spend...
Main influences: trade cycle and fiscal policy
| Tax revenue and borrowing spent by the government for the benefit of the country's citizens.
80
What does the government do when experiencing a recession to the trade cycle?
- revenues
- trade balance
- employment
- budget
- government debt
People lose their jobs and firms find their revenues falling.
This means there is less tax revenue for the government and the injection shrinks.
Equally, as people become unemployed, governments spend more on unemployment benefits.
There will be a budget deficit as the government spends more than it receives.
It is likely to lead to (increasing) government debt as the government borrows to cover its expenditure.
81
What does the government do when experiencing a boom to the trade cycle?
- employment
- revenue
- tax
- government expenditure
- budget
There will be more jobs for people, so unemployment will fall and recently employed people will increase their spending.
Firms will find their revenues increase.
The government will receive more tax revenue as there are more firms and employed workers paying taxes. Equally, spending will fall as there is less unemployment benefits expenditure.
There will be a budget surplus as the government receives more tax than it spends.
82
```
Main influences on the (net) trade balance?
income
rate
state of world
non price
protectionism
```
- Real income /- if rise - normal good imports increase - worsening
- Exchange rates /- strong £ - imports cheap- exports expensive - worsen
- State of the world economy /- domestic deflation - exports more competitive (vice-versa)- whole world... could be equal - though AD will still increase
- non-price factors /- patents, differentiated, specialisation
- degree of protectionism /- subsidies - reduce export price - increase domestic and abroad demand (net trade) Tariffs - make imports more expensive - domestic demand increase - less trade.
83
Short run mean?
at least one factor of production is fixed, they are not all variable
84
Long run mean?
all factors of production can be changed
85
1. What does the AS curve show:
2. What happens to AS curve when at full employment (PPF)?
3. What does the AS curve and a PPF have in common?
1. The aggregate supply curve shows the amount of goods that can be produced at different price levels.
2. When the economy reaches its level of full capacity (full employment – when the economy is on the ppf) the aggregate supply curve becomes inelastic because, even at higher prices, firms cannot produce more in the short term
3. Both show the productive capacity of an economy.
86
Factors determining LRAS?
Available land and raw materials
Quantity and productivity of labour
Quantity and productivity of capital
Technological improvements which affect productivity and output.
The level of entrepreneurship in the economy.
87
The SRAS curve means that capital... therefore, viewed as... because...
In the short-run, capital is fixed. Firms can alter variable factors of production, such as labour.
The SRAS is viewed as elastic, because in the short-run firms can increase output by getting workers to do overtime.
88
Factors affecting the SRAS curve?
Price of raw materials, e.g. oil, food, metals
Cost of labour, (wages, taxes, regulation
Levels of tax and subsidies
89
What is the circular flow of income?
An economic model showing the flow of goods and services, the factors of production and their payments between households and firms within an economy
90
```
What is the simple circular flow of income?
1.
2.
3.
4.
```
1) Households provide firms with factors of production: Land, Labour, Capital and entrepreneurship
2) In order to pay for these factor services, firms pay households rent, wages, interest and profit / dividends
3) Households spend their income on the goods and services produced by firms
4) Firms provide households with goods and services
91
The 4 factors of production and what are they?
```
Land = for buildings and raw material (rent)
Labour = for staffing businesses (wages/salaries)
Capital = for investment (interest)
Entrepreneurship = for creating enterprises/innovation (profit)
```
92
What are withdrawals?
| 3...
Increases in savings, taxes or imports. So reducing the circular flow of income and leading to a multiplied contraction of production (output) - will decrease national income (GDP) if outweighs injections
93
What are injections?
| 3...
Investment, government spending or exports so boosting the circular flow of income leading to a multiplied expansion of output.
94
What is income?
Income is the money that a person receives in exchange for something, e.g. wages from labour or the rent from letting a property. It moves from one agent to another; it is seen as a flow of money. (flow concept)
95
What is wealth?
Wealth is the money that a person holds. It may have built up from wages or investment returns, but it does not go anywhere. It is seen as a stock as it is money that is kept stored. Wealth can be savings accounts or items such as houses (assets). (stock concept)
96
Recession UK 2009 statistics:
1. Economic growth?
2. GDP?
3. Unemployment?
4. Living Standards?
5. Budget Deficit?
6. Interest Rates?
1. Was negative
2. negative/decreased
3. 8% higher
4. Decreased
5. Increase
6. Higher
97
Macro-economic events: influencing national income
1. The rate of VAT increases
2. Tax breaks are given to new start-up businesses
3. The pound strengthens against the Euro
4. Interest rates are cut
5. Workers become nervous about keeping their jobs
1. Decrease
2. Increase
3. Decrease - more exports (cheaper) - less imports
4. Increase (more expenditure)
5. Decrease
98
What an increase in GDP (economic growth) - increase from Y1 to Y2 (Real income(Y))
Increase employment
| Leading to inflation of p1 to p2 of GPL.
99
What is demand pull inflation?
| Not directly in exam
Caused by excessive demand in the economy of goods and services. (too-much money chasing too few goods)
100
Causes of demand-pull inflation?
| Not directly in exam
- Reduced taxation (increased disposable income)
- Lower interest rates (borrowing more attractive and saving less rewarding)
- A general rise in consumer spending (higher incomes and higher confidence)
- Improved availability of credit (banks/building societies widen the availability of credit or make it more affordable
- A weak exchange rate (will boost export growth)
- Fast growth in other countries - (may increase for UK exports)
- General rise in confidence / expectations of future growth (may feed through to higher consumer spending and investment)
- Certainty (links to confidence and assets consumers and firms in their spending and investment decisions
101
lockdown and inflation?
| Not directly in exam
```
Demand-pull inflation:
Increase in consumer confidence
Less Uncertainty
Consumers that have been saving
Spending increase
```
102
What is cost-push inflation?
| Not directly in exam
Occurs when firms respond to rising costs of production by increasing prices
- typically to protect profit margins
As some firms may not be able to absorb increases in the costs - so pass onto consumer
103
```
Causes of cost-push inflation?
1.
2.
3.
4.
5.
(Not directly in exam)
```
1. Wage increases - wages largest single cost. If prices rise - demand for higher wages to maintain real incomes
2. Higher raw material costs
3. Higher taxes
4. Higher import prices /- imported components
5. Natural disasters - may temporarily or permanently disrupt the supply of raw materials - adding to costs to firms
104
What is the multiplier?
| What happens at each stage?
The Multiplier: The process occurs after an injection into the economy and causes it to grow beyond the original amount injected. Each stage gets smaller - as extra money leaks out...
105
Multiplier process?
Money does to income...
Economy...
Income then does to economy...
Though money saved...
but incomes are...
meaning the economy will keep...
As the money goes round and round, it generates more and more income. The economy absorbs the original injection and grows. The income then flows around the economy and the economy grows again.
The money may be saved instead of spent, or it may be spent on imports instead of domestic goods. As firms and households receive the income, it will be taxed. This means the economy will keep growing and multiplying until all the additional income has been withdrawn.
106
Whats a positive multiplier?
| and opposite...
When an initial increase in an injection (or a decrease in a leakage) leads to a greater final increase in real GDP. //Vice versa//
107
Multiplier formula?
```
1 / (sum of propensity to save + tax + import)
e.g.
save = 0.1
tax = 0.2
import = 0.2
Multiplier = 1 / 0.5 = 2
```
108
Factors in favour of high multiplier effect?
- Economy has plenty of spare capacity (negative output gap) to meet higher demand
- Marginal propensity to import and tax is low
- High propensity to consume an extra income (i.e. a low propensity to consume)
109
Factors in favour of low multiplier effect?
- Economy is close to its capacity limits (boom)
- Propensity to import goods and services is high - extra demand leaks from circular flow of income
- Higher inflation causes rising interest rates which then dampens other components of AD
110
What is the problem with using real GDP to measure the productive potential of an economy?
Short term - GDP fluctuates around the long-term trend growth path of output. These fluctuations are known as the trade cycle or economic cycle.
111
What is a peak or boom?
| At top.
National income is high
Economy working at beyond full employment.
Consumption and investment expenditure will be high
Wages will be rising and profits increasing.
Inflationary pressures...
112
What is a downturn?
| decreasing from boom with real output though apply for a recession.
Output and income fall, leading to a fall in consumption and investment.
Tax revenues begin to fall and government expenditure on benefits begin to rise.
Wage demands are moderate as unemployment rises.
Imports decline and inflationary pressures case.
113
Short run economic growth?
- Cyclical changes in real GDP
- Changes in AD (C+I+G+X-M)
- Changes in short AS
- Short term external shocks to both demand and supply
- Short term policy changes e.g. interest rates
114
Long run economic growth?
- Potential output/trend growth
- Productivity of labour and capital
- Technological process and strength of enterprise
- Changes in the Labour force
- Investment rates
115
Demand side causes of business/economic growth?
- Monetary policy/interest rates
- House prices / wealth effect
- Consumer / business confidence
- Changes in real wages
- Multiplier effect
- Exchange rate movements
116
Supply side causes of business/economic growth?
- real business cycle theories of technological shocks
- changes in the rate of producitvity
- population /demographics
- inventory cycles
117
What a more volatile (uncertainty) business cycle means to an economy?
Lower investments - lead to lower long-term economic growth.
118
Why recession can be seen as good?
inefficient firms go out of business and it acts as an incentive to cut costs.
119
Purpose of fiscal (demand-side policies)?
- Stimulate economic growth in a period of a recession
- Keep inflation low (2% target)
- Fiscal policy aims to stabilise economic growth, avoiding a boom and bust economic growth
120
Whats expansionary (or loose) fiscal policy?
(AD1 to AD2 outwards)
(demand-side)
- Involves increasing AD
- Government will increase spending (G) and cut tax(T), lower taxes increase consumer spending because they have more disposable income (C)
- This will tend to worsen the government budget deficit, and the government will need to increase borrowing
121
Whats deflationary (or tight) fiscal policy?
(AD1 to AD2 inwards)
(demand-side)
- Involves decreasing AD
- Therefore the government will cut government spending (G) and/or increase taxes. Higher taxes will reduce
- Tight fiscal policy will tend to cause an improvement in the government budget deficit.
122
```
Strengths and weaknesses of demand side policies?
time
inflation
external
information
```
Strengths:
•Have a time lag of about a year, they are much quicker than supply-side policies and are therefore used to respond to changes in the economy.
Weaknesses:
•Classical economists believe any increase in aggregate demand will only cause prices to increase.
•Although the government can manipulate the economy, the global market has some influences that the government has no control over. The government policy is weak to external shocks.
•Data collection is slow and long-winded. The information provided to governments may not only be inaccurate but also out of date, causing the government to react slowly and possibly incorrectly.
123
What are supply-side policies?
Are governments attempts to increase productivity and increase efficiency in the economy. If successful, they will shift aggregate supply (AS) to the right and enable higher economic growth.
124
What are free market supply-side policies?
Involve policies to increase competitiveness and free-market efficiency. For example, privatisation, deregulation, lower income tax rates, and reduced power of trade issues.
125
What are interventionist supply-side policies?
Involve government intervention to overcome market failure. For example, higher government spending on transport, education and communication.
126
```
Benefits of supply-side policies?
price level
employment
growth
trade and bop
```
1. Lower inflation - shifting AS to the right will cause a lower price level. By making the economy more efficient, supply-side policies will help reduce cost-push inflation.
2. Lower unemployment - can contribute to reducing structural, frictional and real wage unemployment and therefore help reduce the natural rate of employment.
3. Improved economic growth - will increase the sustainable rate of economic growth by increasing LRAS; this enables a higher rate of economic growth without causing inflation.
4. Improved trade and balance of payments - by making firms more productive and competitive they will be able to export more. This is important in light of the increased competition from an increasingly globalised marketplace.
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Examples of free-market orientated supply-side policies?
- Privatisation - sell state owned assets to private sectors - improve incentives
- Deregulation - allow new firms to enter market - open monopolies to competition
- Income tax cuts - greater incentive to work longer hours
- Remove regulations / red tape - make it easier to build new factories and housing
- Flexible labour markets - reduce power of trade unions
- Reduce welfare benefits - increase incentive to get a job
- Free trade agreements - reduce tariff barriers and other obstacles to trade
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Examples of interventionist supply-side policies?
- Public sector investment - in infrastructure it improves transport and reduce costs
- Education - increase funding to schools and universities - improve labour productivity
- Vocational training - Gov't schemes to provide new skills to those who lose jobs
- Housing supply - increase supply of council housing improves geographical mobility
- Health spending - public spending on health can reduce hours lost to ill-health
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limitations to supply-side policies?
1. Productivity growth depends largely or private enterprise and trends in technological innovation - there is a limit to which the government can accelerate the growth of technological change and improvements in working practices
2. Supply-side policies can be counter-productive. For example, flexible labour markets may reduce costs for businesses - but if they cause job - insecurity, workers may be cause demotivated and labour productivity stagnates. Since 2009, the UK has seen a fall in structural unemployment due to more flexible labour markets - but productivity growth is almost stagnate.
3. In a recession, supply-side policies cannot tackle the fundamental problem which is lack of aggregate demand.
4. Time - all supply-side policies take a long time to have an effect on some policies, such as education spending may not influence the economy for 20-30 years.
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What is consumption?
Consumption is the total amount of spending by households, individuals and consumers in the economy.
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The simple,simple circular flow of income?
>Households> ((Factors of production)) >Firms> ((Goods and services)) >Households> ((Expenditure for products)) >Firms> ((Income - wages)) >Households
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Why do lower interest rates (expansionary monetary demand-side) increase overall demand (AD)?
borrow. ..
mortgage. ..
save. ..
exports. ..
- Lower interest rates make it cheaper to borrow; this encourages firms to invest and consumers to spend.
- Lower interest rates reduce the cost of mortgage interest repayments. This gives households greater disposable income and encourages spending.
- Lower interest rates reduce the incentive to save.
- Lower interest rates reduce the value of the Pound, making exports cheaper and increase export demand.
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What is quantitative easing (demand-side)? and used along-side interest rates...
Quantitative easing involves increasing the money supply and buying bonds to keep bond rates low. The hope is that the increase in the money supply and lower interest rates will boost investment and economic activity. The fear is that increasing the money supply could cause inflation.
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The 4 demand-side policies?
Fiscal
Monetary
Quantitative Easing
Devaluation
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The 5 supply-side policies?
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Privatisation/deregulation
Investment in education/training
More flexible labour markets
reduced tax rates
Reduced power of trade unions
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