Theme 2: The UK economy - performance and policies

Question 1

Gross national product

Answer 1

GDP plus net income from abroad

Question 2

GDP

Answer 2

The total value of output in an economy (and is used to measure change in economic activity)

Question 3

GNI

Answer 3

Same as GDP but it adds what a country earns from overseas investments and subtracts what foreigners earn in the country and send back home.

Question 4

Limitations of GDP (5)

Answer 4

1. Does not account for a shift in production to higher quality goods that may improve the standard of living of consumers.
2. Does not account for how hard workers are working to produce this output / how much leisure time they have.
3. Does not account for the underground economy
4. Does not account for negative externalities
5. Does not account for non market production e.g. subsistence farming in LICs.

Question 5

Problems with using market exchange rates to compare GDPs (2)

Answer 5

ERs are very volatile due to speculation - unlikely to be reflective of actual changes in living standards at least in the short term.
ERs are more relevant to products that are traded between countries rather than non-traded products.

Question 6

Big Mac index/basket of goods and purchasing power parity

Answer 6

The Big Mac index looks at the implied PPP exchange rates between countries and the actual exchange rates to judge whether a currency is under or over-valued against the US dollar.

Question 7

Disinflation

Answer 7

Reduction in the rate of inflation

Question 8

Inflation

Answer 8

Sustained increase in the cost of living or the general price level leading to a fall in purchasing power

Question 9

CPI

Answer 9

CPI is a weighted price index. Changes in weights reflect shifts in the spending patterns of households - changes in price of all important types of goods are measured and thus weighted.

Question 10

RPI

Answer 10

CPI but includes for example, taxes and mortgage repayments.

Question 11

Limitations of CPI (4)

Answer 11

1. CPI is not fully representative e.g. 14% of the CPI index is dedicated to motoring costs even though some people don’t even own a car
2. Spending patterns vary between households
3. Does not account for changes of quality in the goods potentially associated with changes in prices.
4. Slow to respond to the change of consumption patterns.

Question 12

Unemployment

Answer 12

Those able, available and willing to work at the going wage but cannot find a job despite an active search for work

Question 13

Under-employment

Answer 13

Those workers that are highly skilled, but working in low paying jobs or low skill jobs, as well as those working part-time that would prefer to be working full time.

Question 14

Claimant count

Answer 14

Includes people who are claiming the Job Seeker’s Allowance

Question 15

Labour Force Survey/ILO

Answer 15

Surveys 44,000 households every month and asks them about economic activity, income etc. as well as unemployment.

Question 16

Types of unemployment (5)

Answer 16

1. Classical unemployment/real wage inflexibility: as a result of government intervention e.g. NMW raising the wage above the market equilibrium.
2. Cyclical/demand deficient unemployment
3. Frictional unemployment: in between jobs
4. Seasonal unemployment: workers without a job due to the time of year
5. Structural unemployment: caused by a lack of skills for the jobs available.

Question 17

What does the balance of payments contain (5)

Answer 17

1. Current account: balance of trade in goods and services, net primary and net secondary incomes
2. Capital account: sale/transfer of patents and other transferable contracts, transfers of ownerships of fixed assets.
3. Financial account: net balance of FDI, net balance of portfolio (debt and equity) flows, balance of banking flows
4. Balancing item
5. Changes to the values of gold and FOREX reserves.

Question 18

Current account deficit/surplus

Answer 18

Where the value of the goods and services which it imports exceeds/is less than the value of the goods and services which it exports

Question 19

Influences on investment (6)

Answer 19

1. Rate of economic growth - if the economy is expanding, firms will need to increase their investment to have the capital equipment to produce more goods and services.
2. Business expectations and confidence/animal spirits - affects whether firms believe that their profits will rise or not.
3. Demand for exports
4. Interest rates
5. Access to credit - as lots of investment is financed by borrowing
6. The influence of government and regulations - through tax levels or guaranteeing loans, the government can affect how much firms are willing to invest.

Question 20

Influences on net trade balance

Answer 20

1. Real income - rising real incomes will suck in more imports
2. Exchange rates - rise in the value of the pound means that it costs foreigners more to buy pounds with their local currency.
3. State of the world economy - if the UK’s trading partners are doing well, this is likely to increase the volume of exports.
4. Degree of protectionism - the greater the degree of protectionism internationally, the more difficult it will be for UK firms to export.
5. Non-price factors - the design and quality of goods that are exported and imported can affect the extent to which they are traded.

Question 21

Circular flow of income, what is it, what does it include

Answer 21

The circular flow of income and spending shows connection between different sectors of an economy.
Leakages/withdrawals: savings, taxation, imports
Injections: investment, government spending, exports.

Question 22

Wealth

Answer 22

Refers to the stock of assets held by an individual or household at a single point in time

Question 23

Income

Answer 23

Refers to the money received by an individual or business in exchange for the provision of a good or service or through investing capital.

Question 24

Multiplier effect

Answer 24

An initial change in AD can have a much greater impact on the level of equilibrium national income - injections of new demand into the circular flow of income can stimulate further rounds of spending

Question 25

MPC

Answer 25

1/(1-MPC)

Question 26

Actual growth

Answer 26

Growth in the quantity of goods and services produces is measured by the percentage change in GDP.

Question 27

Potential growth

Answer 27

The change in the productive potential of the economy over time. It is shown on a diagram by the shift to the right in the LRAS curve or the PPF

Question 28

The output gap

Answer 28

The difference between the actual level of real GDP and its estimated long term value at a point in time is known as the output gap

Question 29

Hysterisis (may occur following a deep recession)

Answer 29

Economices do not bounce back to their previous trend level of growth.

Question 30

MEPOs (7)

Answer 30

Economic growth, low unemployment, low and stable rate of inflation, B of P equilibrium on current account, balance government budget, protection of the environment, greater income equality

Question 31

Consequences of inflation (7)

Answer 31

1. Redistribution of income - if staple/basic necessities experience particular inflation e.g. gas 2. Falling real incomes 3. Negative real interest rates 4. Higher costs of borrowing 5. Risks of wage inflation 6. Business competitiveness - if one country has a much higher rate of inflation that others for a considerable period of time, this will make its exports less price competitive in world markets 7. Business uncertainty

Question 32

Consequences of deflation (8)

Answer 32

1. Consumers hold back on spending 2. Real debts increase 3. Real cost of borrowing increases 4. Lower profit margins 5. Lower confidence 6. Income distribution - redistribution of income from debtors to creditors, but debtors may default (7. Can make exports more competitive in the long term) 8. Higher unemployment

Question 33

Strengths of demand side policies (3)

Answer 33

1. Quick response according to Keynesian economics (not according to Classical economic theory) 2. Can be used further to lower interest rates; which can only be lowered to a certain extent 3. Boosts economy using multiplier (Keynesian)

Question 34

Weaknesses of demand side policies

Answer 34

1. May conflict with MEPOs 2. Increase national debt (3. May have a time lag) 4. Difficult to target right areas 5. Inflation

Question 35

Market-based supply side policy

Answer 35

Involve policies to increase competitiveness and competition e.g. deregulation, privatisation

Question 36

Interventionist supply side policy

Answer 36

Involve government intervention e.g. government spending

Question 37

Phillips curve

Answer 37

Shows that inflation and unemployment have a steady inverse relationships - proven wrong following '70s stagflation.

Question 38

Strengths of supply side policies

Answer 38

1. Sustainable economic growth 2. Reduces unemployment - however, also requires a large increase in AD, particularly if operating at the horizontal part of the LRAS curve. 3. Can improve the current account balance if the supply-side policies can be directed at increasing exports.

Question 39

Weaknesses of supply side policies

Answer 39

1. Can create downward deflationary pressure, or inflationary pressure if AD exceeds the increase in LRAS. 2. May increase distribution of income through policies like abolishing the NMW.