Topic 3 - The Uk Macroeconomy Flashcards
(233 cards)
1
Q
What is economic growth ?
A
Economic growth is defined as an increase in real GDP. That is an increase in the real value of goods and services produced in an economy in a given period of time.
2
Q
How often is economic growth calculated?
A
It is usually calculated on an annual or quarterly basis and is given as a growth rate.
3
Q
If real GDP is growing what does this mean for the value of goods and services ?
A
the value of goods and services being produced is rising. So it should mean, ceteris paribus (everything else equal), that incomes and standards of living are rising
4
Q
What’s a better measure of economic strength than GDP ?
A
real GDP per capita (per capita means divided by the population).
E.g. China’s real GDP is X, but its GDP per capita is Y because it has so many people. Whereas Qatar’s real GDP is X but its GDP per capita is higher. So the “average” person has a higher income in Qatar than in China.
5
Q
What’s an additional exchange rate adjustment that equalises the price of internationally traded goods across countries
A
Purchasing power parity (PPP)
6
Q
What’s is this ?
If, at a certain exchange rate, it is cheaper to buy goods in one country than another, businesses will buy goods in the cheaper country and sell in the other for a profit.
A
This is arbitrage. It forces prices and exchange rates to align over time, e.g. increased demand in the cheaper country might lead the price there to eventually increase, closing the ‘gap’.
7
Q
What are the benefits of (purchasing power parities) PPP?
A
The PPP exchange rate remains fairly constant year round, so it can be easily compared.
Exchange rates will often get closer to the PPP as time passes.
Knowing the PPP will allow you to track and predict exchange rate relationships.
PPP can help you to examine the relative living conditions of different countries.
8
Q
What is the term that describes being able to buy goods in cheaper countries and sell them in other countries for profit?
A
Arbitarge
9
Q
National income is used to assess what ?
A
changes in living standards in a country, and between countries, over time
10
Q
What is national income defined as ?
A
the total value of goods and services produced in an economy in a given period of time
11
Q
What is national income the same as ?
A
national output, or GDP
12
Q
What is higher GDP correlated with ?
A
higher incomes and so a higher standard of living
13
Q
What can we use national income over time to see ?
A
whether people are generally getting richer over time or not.
14
Q
What are the issues with national income being used to compare standards of living ?
A
Two countries could have the same level of GDP (national income), but the country with a larger population will have a lower ‘average’ GDP per person. So we can improve national income data by looking at GDP per capita (GDP divided by population).
15
Q
What is nominal GDP ?
A
GDP at current prices – it means the GDP data has not been adjusted for inflation
16
Q
What is real GDP ?
A
Real GDP is inflation adjusted. Adjusting for ‘Purchasing Power Parity’ may help to solve this issue
17
Q
Two countries could have the same level of GDP (national income), but their cost of living could be higher in one country.
So, the same income purchases fewer goods and services, and quality of life will be poorer.
What should be used to compare these ?
A
Rather than using current GDP, we should use real GDP.
18
Q
In some countries, especially developing countries, why is the quality of GDP weak ?
A
They have poor data collection agencies
19
Q
What is the shadow economy ?
A
illegal activities that create GDP but are not recorded in the formal economy.
E.g. the sale of illegal drugs or undeclared ‘cash-in-hand’ transactions.
20
Q
Two countries could have same reported real GDP, why might one of the countries have an actual income that’s higher ?
A
Some countries add an estimate for the shadow economy
but one may have a larger shadow economy, so the others actual income is higher.
21
Q
Explain real variation and inequality
A
National income is an aggregate of the countries entire output. But often there is variation.
E.g. in the UK, over 25% of GDP is created in London.
Two countries could have the same GDP but the income and wealth could be distributed differently.
E.g. Qatar has a high GDP per capita, but it is not distributed very equally.
22
Q
What is sustainability defined as ?
A
defined as “the ability to meet the needs and wants of the current generation, without compromising the ability of future generations to meet their needs and wants”.
23
Q
GDP measures the total value of goods and services produced but what does it not take into account ?
A
GDP measures the total value of goods and services produced but it doesn’t take into account the cost of making that output.
A country could have a high GDP but it could be using up all of its raw materials, minerals in doing so. So it is unsustainable.
24
Q
Why is national income not always a good measure of economic growth ?
A
Doesn’t take into account:
Sustainability
Composition of GDP
National happiness
Working hours and leisure time
Externalities
25
What is inflation ?
Inflation is defined as a persistent increase in the general price level over a given period of time
26
How often are inflation figures given ?
Inflation figures are normally given on an annualised basis
27
What are the most common measures of inflation ?
CPI (Consumer Price Index)
RPI (Retail Prices Index)
28
How is inflation measured ?
They are calculated by measuring the change in the value of a basket of goods and services.
29
How is the rate of inflation each year found ?
In the UK, the Office for National Statistics (ONS) calculates the inflation rate by collecting prices on a basket of around 700 representative goods and services.
Each item is weighted in the basket according to the % of household income spent on them. So higher weights means if the price of that item changes, it has a larger impact on the overall value of the CPI and inflation.
The basket (items in it and the weights) is updated once a year to reflect changing consumer consumption behaviour.
30
How I’d inflation an economic indicator ?
One reason inflation is an indicator of the strength of the economy is because high and unexpected inflation would mean goods and services are becoming unaffordable as the purchasing power of income falls.
31
How do you calculate an index number ?
You need to choose a "base". This is commonly a year but doesn't have to be.
It is the “thing” that everything else is being compared to.
E.g. if the base year is 2008, then the index number in 2009 is being compared to 2008, the chosen base year.
It is convention to set the base year index number equal to 100.
To calculate an inflation rate we use the following formula: (New value / Base year value ) x 100.
32
If the price level increases from an index of 120 to 132, what does this indicate?
Increase in price of 10%
33
What’s deflation ?
Deflation is defined as a persistent decrease in the general price level, over a given period of time.
Prices are going down.
34
What is disinflation ?
Disinflation is a decrease in the rate of increases of prices – it is when inflation falls but remains positive.
If the inflation rate falls from 5% to 2%, prices are still rising, just at a slower pace.
Prices are still going up!
35
If the base year data (where the index = 100) for a firm's revenue is £200 000, what is the index number for revenue equalling £600 000?
300
36
What is the reason for cost push inflation ?
due to a rise in costs of production
37
What happens to the SRAS when cost push inflation occurs ?
causing the SRAS to shift up
38
Why do prices rise for consumers in cost push inflation ?
a rise in costs of production occurs, causing the SRAS to shift up, and reducing profit margins of firms. This then prompts firms to push up the final price of goods and services to maintain profit.
39
What are some causes of cost push inflation ?
National minimum wage increases.
Trade union wage increases.
Increase in world commodity prices, e.g. oil price rises globally.
External supply-side shocks, e.g. bad harvest abroad causing the price of wheat to rise.
Rise in indirect taxes, e.g. VAT (if it is passed on to consumers).
Rise in corporation tax (if it is passed on to consumers).
Falling productivity (which causes unit costs to then in that each good costs more to produce).
40
What happens when there’s a growth in the money supply ?
A growth of the money supply can also cause inflation.
This is because more money is pushed into the economy and therefore the purchasing power of the currency decreases. This leads to price rises.
41
What’s the impact of currency depreciation?
Exchange rate depreciation causes the price of imports to rise in domestic currency terms.
Note the exchange rate depreciation could happen because of events in another country that causes their exchange rate to appreciate, so causing the Pound to depreciate.
The Pound depreciated immediately after the EU referendum in June 2016, causing the price of imports to rise and inflation to increase.
42
What is the reason for demand pull inflation ?
When’s there’s an increases in aggregate demand outstripping aggregate supply. The economy is close to full employment, and increases in AD lead to the general price level rising because supply cannot keep up with increased demand.
43
What are some reasons for demand pull inflation ?
Exchange rate depreciation – causes the price of exports to be cheaper in foreign currency terms and thus demand for exports rises. This causes the value of exports to increase, so X-M increases.
Rising animal spirits (confidence) e.g. due to positive wealth effect from rising house prices.
Excessive borrowing.
Global economy experiencing faster growth in incomes and buying a lot of goods from the UK, causing UK exports and AD to rise quickly, causing demand-pull inflationary pressure.
Excessively 'loose' fiscal policy: income taxes could be cut too much or government spending be increased too quickly.
Excessively 'loose' monetary policy: interest rates could be cut too much or too quickly and Quantitative Easing could be too high.
44
What is the consequence of inflation on consumers ?
For individuals, inflation will erode the real value of money. That is to say, real incomes will fall, as the purchasing power of incomes falls. So standard of living also falls.
Inequality rises because the more skilled workers can negotiate nominal wage increases that keep pace or outstrip inflation.
Cash loses value more quickly. This means that some consumers take more trips to the bank ('shoe leather' costs).
Menu costs are the costs firms face of keeping prices updated in shops.
45
What are the consequences of inflation on savers and borrowers ?
Savers lose out because the real interest rate (nominal interest rate minus inflation) falls as inflation rises.
Borrowers gain because the real interest rate falls.
Indebtedness falls because the real value of debt falls as inflation erodes the real value of repayments.
46
What is the consequence of inflation on firms ?
Business uncertainty – volatile prices means firms may reduce investment because it is riskier.
Falling international competitiveness – a high inflation rate vs main trading partners will mean a country's exports will be less internationally competitive.
47
What is the wage price spiral as a consequence of inflation .
As inflation rises, people start to expect higher inflation.
This leads to them asking for higher nominal wage rises to keep pace with the rising cost of goods in shops.
Firms may grant this to begin with, but then as their costs are also rising, they may have to pass this on to consumers with higher prices. So they demand higher wages again.
This can become a vicious spiral.
48
What is inflation expectations rose as a regular of inflation ?
this can cause people to spend now to avoid the future higher prices.
This could lead to demand rising, causing prices to rise even further.
Expectations of higher inflation could cause higher inflation: a self-fulfilling prophecy!
49
What do the consequences of inflation depend on ?
Is it unexpected or expected ?
Is it a temporary or persistent problem?
The extent to which workers have negotiation power in terms of unions or skill level.
What is happening to nominal interest rates via the central bank response?
What is happening to inflation rates in the rest of the world?
50
What is unemployment?
defined as the number of people who are actively seeking a job but currently without a job.
51
What are some consequences of unemployment for workers ?
Falling incomes.
Poverty.
Depression.
Health problems.
Poor standard of living.
Debt problems.
52
What is hysteresis ?
A rise in unemployment caused by a recession may cause the natural rate of unemployment to increase.
This is because when workers are unemployed for a time period, they become deskilled and demotivated and are less able to get new jobs - this is known as 'hysteresis'.
53
What are the consequences of unemployment on the wider economy ?
Crime (negative externalities).
Higher fiscal deficit as tax revenues fall and welfare payments rise.
If there is hysteresis, the LRAS of the economy shifts in (its long run potential falls).
Loss of workers to foreign countries.
May cause rising income inequality.
54
If you are not seeking work what are you known as ?
Economically inactive
55
What are the two main measures of unemployment ?
Claimant Count
International Labour Organisation (ILO) measure
56
What is the claimant count ?
The Claimant Count (CC) is defined as a person who is receiving the Job Seekers’ Allowance
57
What is the ILO ?
The ILO measure defines unemployment as someone who has been actively seeking work for the past four weeks but ready and able to start in the next two weeks. This is collected in the UK by the Labour Force Survey.
58
What are the different types of unemployment?
Frictional unemployment
Structural unemployment
Cyclical unemployment
Seasonal unemployment
Real-wage unemployment
59
What is frictional unemployment ?
Frictional unemployment happens when people are between jobs.
Most economies will always have some level of frictional unemployment and it isn't a huge concern for governments.
In fact, it can even be a positive sign for an economy because it may indicate that workers are willing to take risks by moving in search of better pay or a job they are better suited to.
60
What is structural unemployment ?
This happens when there is a mismatch between the skills that workers have and the skills that firms are looking for.
This is linked to changes in an economy over time and the changing demands of firms.
For example, de-industrialisation and the closure of the coal mines in the UK in the 1980s led to high levels of unemployment in the affected areas.
61
What is cyclical unemployment?
Cyclical unemployment is unemployment that is related to the business cycle. It is caused by the economy moving from expansion to recession, and is short term.
This is also known as Demand Deficient or Keynesian unemployment.
62
What’s seasonal unemployment?
Unemployment due to the seasons of the year (e.g. ski instructors in the summer).
63
What is real wage unemployment?
Real-wage unemployment is because real wages are too high in a market and they are above the 'market-clearing' (equilibrium) wage rate.
This is also known as Classical unemployment.
64
What are the reasons for real wage unemployment?
Free market economists might suggest that real-wage unemployment is caused by factors such as:
High trade union power.
High national minimum wages.
'Sticky' wages (slow to adjust).
65
If there was a higher rate of employment, what would occur ?
there would be economic growth:
Incomes would rise, people would consume more, the government could tax more.
However, people may also demand more imports and inflation may occur.
66
If the economic inactivity rate rose, what would happen to the economy ?
the government would be impacted:
Government expenditure (on benefits, pensions etc.) would rise
The government would receive less income.
67
If there was a higher rate of unemployment, what would happen in the economy ?
there would be slower economic growth.
Average income would be reduced, consumption would be reduced, the government would have to pay more benefits and receive less tax.
68
What are the two …-side factors that affect levels of employment and unemployment?
Both demand-side and supply-side factors
69
In the labour market what does supply side refer to ?
the supply of labour by workers
70
What are some supply-side factors that affect employment and unemployment?
Labour market flexibility, e.g. trade union strength
Skills of workers
Geographic mobility of workers
Occupational mobility of workers
71
In the labour market what does demand-side refer to ?
the demand for labour from firms
72
What are some demand-side factors affecting employment and unemployment ?
Health of firms, e.g. profit levels, demand for goods.
Confidence of firms.
Overall strength of economy.
Government intervention to encourage hiring.
Level of labour market regulation/costs of hiring.
73
If there’s a constant high level of unemployment in an economy what are the consequences ?
Fiscal issues
Living standard and inequality
Reduced output
Social issues
74
How are fiscal issues a consequence of high levels of unemployment?
'Automatic stabilisers', such as unemployment benefits, would increase government spending when unemployment is high.
The government would also receive less income tax and so would not have as much revenue to invest in public services to address the problems caused.
75
How is inequality and a fall in living standards a consequence of unemployment?
It is likely that those unemployed will suffer a dramatic fall in their standard of living.
High levels of unemployment may also increase inequality within an economy - those without a job 'falling behind' those who are earning and also potentially disadvantaging future generations who grow up in communities without work.
76
How is reduced output a consequence of high levels of unemployment?
If unemployment is not due to workers being replaced with capital, it is likely that real GDP will fall with increased unemployment.
Reduced confidence and multiplier effects could magnify the negative impact upon the economy.
77
How are social issues a consequence of unemployment?
High levels of unemployment can also be associated with increased rates of crime and other such activities.
These cost the government through expenditure on policing and also give rise to negative externalities.
78
What are the 3 main reasons for hysteresis ?
The insider-outsider effect
The long-term unemployed withdraw
Capacity scrapping
79
What is the insider-outsider effect ?
A fall in AD reduces output and employment as some people lose their jobs.
The insiders who keep their jobs have strong bargaining power inside their firms. Their firm-specific skills and bargaining power mean that they claim wage rises, rather than hiring more 'outsiders'.
80
What is the long-term unemployed withdraw ?
People who are unemployed for a long time are likely to lose their skills, or they may become less motivated to do work in future
The unemployed outsiders become poor substitutes for workers in work. So the pool of available labour to do a given job falls
81
What is capacity scrapping ?
When AD falls and output falls, firms may close some factories or offices. They scrap some of their output capacity.
When AD recovers, firms reach high capacity utilisation earlier.
82
Which example is often cited as an example of the insider-outsider effect in action?
Spain after the eurozone crisis
83
Which of the following is the insider-outsider effect most likely to explain in an economy?
Very high levels of youth unemployment
84
What does the balance of payments show ?
a record of all transactions that a country does with the rest of the world
85
What is the balance of payments made up of ?
Current account
Capital account
Financial account
86
What is the current account made up of ?
Trade in goods and services (X-M).
Net primary income - net factor income from abroad (e.g. remittances, profits, interest on dividends).
Net secondary income - net unilateral transfers (e.g. foreign aid).
87
What is the capital account made up of ?
Sale/transfer of patents, copyrights, franchises, leases and other transferable contracts, and goodwill.
Transfers of ownership of fixed assets.
88
What is the financial account made up of ?
Net foreign ownership of domestic assets.
Hot money flows
89
What is the current account made up of ?
Unilateral transfers
Merchandise trade balance
Income receipts and payments
Services trade balance
90
What are unilateral transfers?
payments by governments or individuals in which money is sent abroad without any direct good or service being received.
The UK sending humanitarian aid to African countries, India or North Korea would count as a unilateral transfer.
91
What is merchandise trade balance ?
The merchandise trade balance is made up of the exports and imports of goods.
The sale of Aston Martins made in the UK would count as an export of goods in this section of the balance of payments.
92
What are income receipts and payments ?
Includes money received from foreign investments.
Investment income can come from investments abroad.
When someone invests in the US and makes a return, this is then transferred to the person in the UK who owns the asset.
93
What is the service and trade balance ?
This is made up of the exports and imports of services.
Barclays selling financial services (e.g investment bank consultancy fees) to a company based in Saudi Arabia would count as the export of services.
94
What is the calculation for the current account?
Value of exports - value of imports
95
What causes a current account deficit ?
Low productivity, meaning the final price of the goods are likely to be higher.
Inflation being higher domestically than abroad, reducing the international competitiveness of domestic goods.
A strong exchange rate, reducing the price of imports and increasing the price of exports.
Non-price factors, such as poor quality of goods and services.
Supply-side constraints, which could cause a lot of goods being imported from abroad.
96
Is a current account deficit a concern?
If a deficit is because of capital goods imports, then it is likely to be good for future productivity and future growth.
If a deficit is because of the purchase of current goods, it will be good for the short-term standard of living.
If it because of a lot of FDI in the past, profits are being repatriated today. This means the investments were profitable.
If the deficit is a high % of GDP and is getting worse, this may be worrying.
If nobody wants to buy a country's exports, then this may be concerning.
97
What are the effects of a current account deficit ?
A current account deficit needs to be financed by a financial account surplus - so it will become a problem if foreign investors stop wanting to purchase assets in that country.
If a country has a free floating currency, the currency will depreciate. This may partially offset the uncompetitiveness of exports.
This will also cause the price of imports to rise though, leading to higher prices for consumers and potentially cost-push inflation
98
If there’s a current account surplus what does this mean for an economy ?
The economy is exporting a lot of goods.
99
If there’s a current account deficit what does this mean for an economy ?
The economy is importing lots of goods.
100
What is the Aggregate Demand (AD) of an economy equal to ?
Aggregate Demand (AD) = Consumption (C) + Investment (I) + Government Spending (G) + Net Trade/Exports-Imports (X-M).
101
What is the most important component of the aggregate demand curve ?
Consumption
102
What is the shape of the AD curve?
The AD curve is downward sloping.
Consumption will fall as the price level rises - a movement (not a shift) along the AD curve.
103
Why does AD shift ?
AD shifts because of a change in any of
consumption
investment
government spending
exports or imports.
This can be caused by changes in behaviour or changes in government policy.
E.g changes in business confidence or taxation. If firms are more confident, they are more likely to borrow to finance investment. This shifts AD right and AD is now higher at every price level
104
What are demand-side shocks ?
A demand-side shock is anything (positive or negative) that causes AD to change
105
What are examples of negative demand side shocks ?
Examples of a negative shock could be an interest rate rise, a collapse in the housing market, etc.
As well as a fall in real GDP, this could have a knock-on effect on confidence, leading to further falls in activity.
The multiplier and accelerator effects could magnify the impact of any initial negative shock.
106
If there are negative demand side shocks what should Keynesians suggest ?
Keynesians may suggest government intervention would be required at this point.
107
What are reasons for movements along the AD curve ?
Movements along the AD curve are caused by a change in the average price level (the two have an inverse relationship).
E.g. a rise in the average price level leads to a contraction of AD.
The average price level can lead to several things:
Real incomes: A rise in the average price level can lead to the real value of income to drop.
Balance of trade: If the average price level of a foreign country fell, domestic consumers would demand more imports, causing a contraction in AD.
Interest rates: If the average price level rises, there will be inflation.
108
What is Aggregate Demand (AD) defined as ?
Aggregate Demand (AD) is defined as the total value of planned expenditure on goods and services produced in an economy in a given period of time.
109
What is the formula for AD ?
The formula for AD is AD = C + I + G + (X-M).
C is Consumption.
I is Investment.
G is Government Spending.
X is Exports.
M is Imports.
110
What factors affect the level of consumption (C) ?
Wealth levels.
Income levels.
Future expectations of inflation.
Animal spirits (confidence).
Unemployment levels.
Job security.
111
What is the definition of investment ?
Investment is defined as expenditure that increases the capital stock of a country.
Investment in physical capital would be expenditure by firms on plant and machinery.
Investment in human capital is expenditure by firms on the skills of its workers e.g. training programmes.
112
What factors affect the level of investment (I) ?
Interest rates.
Future growth and demand.
Profitability.
Government policies e.g. corporate tax, subsidies.
Efficiency of financial system.
113
What are the types of government spending, what’s the difference between current spending and capital spending ?
Government spending could be on current spending or capital spending:
Current spending is on transfer payments such as benefits, or on the day to day running of government e.g. salaries, utility bills.
Capital spending is on long-term spending that increases the productive capacity of the economy e.g infrastructure projects.
114
What factors affect the level of government spending ?
Cost of borrowing.
Fiscal deficit or debt targets.
Levels of national debt.
State of the economy.
Confidence in the economy.
Political bias.
115
What factors affect the level of exports and imports ?
The exchange rate determines relative prices of exports and imports.
The quality of goods affects international competitiveness.
Relative inflation rates affect domestic vs international prices.
Relative levels of income. The higher the domestic income, the higher the marginal propensity to import.
How much spare capacity there is to supply resources. The less there is, the more raw materials will need to be imported.
116
What is disposable income ?
Disposable income is the amount of money that people have left after paying their income taxes.
Saving is the part of disposable income that is not spent on things like food, clothing and rent
117
What will an increase in disposable incomes often lead to ?
An increase in disposable income will lead to an increase in consumer spending unless consumers save all of this rise (which they almost never do).
Research in the USA found that a large proportion of the 2001 Bush tax cuts was spent by consumers, rather than saved.
118
What is saving ?
Savings is the part of disposable income that is not spent.
The savings ratio is the ratio of savings to income (S/Y).
Lots of economic models assume that investment is equal to savings. When you save money in a bank account or buy stocks, this money is then invested by banks or corporates.
If the savings ratio rises, it is likely that consumption will fall. This is because: savings + consumption = disposable income.
119
What is the savings ratio ?
The savings ratio is the ratio of savings to income (S/Y).
Lots of economic models assume that investment is equal to savings. When you save money in a bank account or buy stocks, this money is then invested by banks or corporates.
120
If the saving ratio rises what happens to consumption ?
If the savings ratio rises, it is likely that consumption will fall.
This is because: savings + consumption = disposable income.
121
What are determinants of consumer spending ?
The interest rate (return) being received on savings.
The level of consumer confidence in the future.
Wealth effects
Inflation expectations
Level of income
122
How can the interest rate (return) being received determine consumer spending ?
The interest rate (return) being received on savings. If the interest rate rises, then saving is more attractive, so consumers will spend less and save more.
123
How can the level of consumer confidence in the future determine consumer spending ?
The level of consumer confidence in the future. If confidence is low, consumers will spend less and save more.
124
How can wealth effects determine consumer spending ?
Wealth effects happen if asset prices rise and consumers feel as though they have more money. They may spend more if share prices or property prices rise.
125
How can inflation expectation determine consumer spending ?
Inflation expectations (if prices are going to rise in the future, people may spend now and save less now).
Level of income (people with higher incomes tend to save more – they have a higher marginal propensity to save, that is for every extra pound people get, they save more as they get richer).
126
How can levels of income determine consumer spending ?
Level of income (people with higher incomes tend to save more – they have a higher marginal propensity to save, that is for every extra pound people get, they save more as they get richer).
127
How do firms get their money from banks to invest ?
Banks recycle savings in bank accounts and lend to companies. This allows them to invest in long-term projects.
(This is why saving=investment)
128
What is gross investment ?
Gross investment is the total amount that companies spend on investment.
129
What is net investment ?
Net investment is the gross investment - depreciation. Depreciation is the deterioration of assets over time. Cars don't last forever and depreciate gradually until they are useless and have no value.
130
What is investment influenced by ?
Rate of economic growth
Business expectations
Keynes 'animal spirits'
Export demand
Interest rates
Access to credit
Government and regulation
131
How does the rate of economic growth effect investment?
Investment is usually measured as a % of GDP. If GDP is high and rising, then investment is likely to rise too.
A high rate of economic growth also signals economic strength. This can give businesses confidence in the future and they will invest to increase their productive capacity, expecting increases in demand to continue in the future.
132
How do business expectations effect investment?
If businesses expect demand for their goods and services to continue rising then they are likely to invest to increase their productive capacity.
133
How do animal spirits effect investment?
Keynes referred to 'animal spirits', explaining why firms will be overoptimistic and invest excessively in good times, before reducing investment too much when consumer spending is lower and business confidence is weaker.
134
How do export demands effect investment?
Exports are a component of aggregate demand.
If international demand for a firm's goods or a nation's goods rose, then it is likely that they would invest to increase the capacity of their production.
135
How do interest rates effect investment?
Companies often have to borrow money to invest.
Apple's new campus, Apple Park cost $5bn. If it had to borrow that money, an interest rate of 10% p.a. would lead to $500m of annual debt repayments. If the interest rate was 1%, it would lead to $50m of annual debt repayments.
136
How does access to credit effect investment?
Higher access to credit makes it more likely that firms will be able to borrow to invest.
In the 2008 financial crisis, many businesses said that they were unable to borrow from banks. Banks reduced their lending because they had made such large losses in the financial crisis.
137
How does do governments and regulations effect investment?
Governments can subsidise or encourage investment in certain industries.
Usually, investment support is concentrated in a few industries, like Renewable Energy, Artificial Intelligence or Healthcare.
138
What is fiscal policy ?
Fiscal policy involves changing government spending and taxation, according to the economic conditions:
AD = C+I+G+(X-M). So changing G will affect AD.
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What are expansionary fiscal policies?
Expansionary fiscal policy increases the level of aggregate demand (AD) by either increasing government spending or cutting taxes. This can:
Increase consumption by increasing disposable income because of tax cuts.
Increase investment by cutting business taxes.
Increase government purchases because government spending itself rises (e.g new hospitals & schools).
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What do expansionary fiscal policies do to AD?
Expansionary fiscal policy shifts AD rightwards because AD has increased.
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What are contractionary fiscal policies ?
Contractionary fiscal policy decreases the level of AD by decreasing:
Consumption.
Investments.
Government spending.
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What do contractionary fiscal policies do to AD ?
Contractionary fiscal policy shifts the AD curve leftwards as AD has fallen.
143
What is the trade cycle?
The trade cycle displays a country's economic growth
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What are the fluctuations in the trade cycle ?
Economic boom - building economic growth.
Peak - climax of economic growth and rates beginning to fall.
Economic downturn - economic growth rate falling.
Trough - the bottom of the cycle where growth rates begin to rise.
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How is government spending impacted by an economic boom ?
In an economic boom, there is more spending and higher incomes which means the government receives more tax. The government also pays less benefits.
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How is government spending impacted by an economic downturn ?
In an economic downturn, there is less spending and lower incomes which means the government receives less tax. The government also pays more benefits.
147
What is a recession ?
When there is negative economic growth for two consecutive quarters
148
What is net trade ?
The balance of exports and imports
149
In 2016, describe what the Uk exports
Valued at around £300bn.
The main exports in the UK were financial services, cars, wholesale medicines, gas turbines, petroleum and gold.
The leading recipients of UK exports are the USA, Germany, the Netherlands and France.
150
Since 200 what’s happened to the UKs exports ?
Since 2000 the UK has decreased its share of exports to the EU from 55% to 45%, taking advantage of the rapid economic growth of countries such as Brazil, China, Russia and India.
As London grew as a financial hub from 2000-2008, there was an increase in financial services exported to the rest of the world. This slowed after the global financial crisis of 2008, but is still a major contributor to UK exports.
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In 2016, describe the UKs imports
In 2016, UK imports were valued at around £500bn.
The main imports were cars, vehicle parts, aircraft, gold, petroleum and wholesale medicines.
The leading suppliers of imports to the UK are Germany, China, the USA and the Netherlands
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How has the UKs imports changed since 200 ?
Since 2000, over 50% of UK imports have come from the EU.
The rapid growth of China as an exporter has meant that lots of UK imports now come from China.
The decline of the UK manufacturing industry has meant that we import lots more manufactured goods, including computers. Between 1986 and 1998, the UK average a small trade deficit of around £5bn. This then grew until 2002 where it reached £30bn and has roughly stable ever since.
153
What factors influence net trade ?
Spare capacity
Exchange rates
Relative incomes
Protectionism
Inflation rates
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How does spare capacity influence net trade ?
How much spare capacity there is to supply resources. The less there is, the more raw materials will need to be imported.
155
How do exchange rates influence net trade ?
The exchange rate determines relative prices of exports and imports.
The quality of goods affects international competitiveness
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How do relative levels of income influence net trade ?
Relative levels of income. The higher the domestic income, the higher the marginal propensity to import.
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How does protectionism influence net trade ?
If a country introduces protectionist measures, imports are less desirable.
Protectionism is an attempt to improve the ratio of exports to imports and increase AD.
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How do relative inflation rates influence net trade ?
Relative inflation rates affect domestic vs international prices.
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Why is the Uk an exporter of financial services ?
The UK, and in particular London, is a global financial hub.
With advancements in technology firms here can do business with the rest of the world. As a result, the UK is a major exporter of services like insurance and investment banking.
160
What are the determinants of consumer spending?
Wealth effects
Wealth effects happen if asset prices rise and consumers feel as though they have more money. They may spend more if share prices or property prices rise. UK house prices have risen steadily since 2010 which has contributed to people feeling wealthier and increasing consumption.
Inflation expectations
Inflationary expectations are important. If prices are going to rise in the future, people may spend more now and save less. And, because savings represent forgone consumption, this would raise consumer spending.
The interest rate
The return being received on savings impacts consumer spending. The interest rate represents the cost of borrowing and the price of saving. If the interest rate rises, then saving is more attractive, so consumers will spend less and save more. UK interest rates have been kept low since 2008, which has impacted consumer spending.
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What is AS ?
AS is the total quantity of output firms will produce and sell at a given price level.
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Movement along the SRAS curve is caused by what ?
A change in the average price level.
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What’s the difference between SRAS and LRAS ?
In the short run, at least one of the 'factors of production' (labour, land, enterprise or capital) are fixed.
In the long run, all factors of production are variable.
In the long run, the economy is operating at full employment (this is known as the natural rate of unemployment).
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What’s causes shifts in the SRAS ?
Business costs: labour and raw material costs may rise.
Exchange rates: the exchange rate may lead to higher prices of imports.
The government can impose taxes which can increase the cost of producing goods or services.
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Describe the SRAS curve
The SRAS curve is upward sloping.
The SRAS curve shows the total quantity firms will produce at each price level.
The curve shows how suppliers will react to a higher price level for final outputs of goods and services, holding inputs constant.
This is represented by the increasingly upwards sloping curve.
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What is a supply side shock ?
A supply-side shock is anything (positive or negative) that causes SRAS to change.
Examples could be a bad harvest, technological improvement, or a new mineral discovery.
A rise in global oil prices will cause the SRAS to shift left as imported costs of production rise.
This will lead to the equilibrium level of real GDP falling, and the General Price Level to rise - that is, cost-push inflation, potentially causing the purchasing power of consumers to fall if wages have not caught up.
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What’s is underlying economic growth shown by ?
A rightward shift in the long-run aggregate supply curve (LRAS). This represents an increase in the productive capacity of the economy.
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What cause shifts in the LRAS ?
The most important factor to shift LRAS outwards (to the right) is productivity growth. But it could also be an increase in the amount of factors of production (e.g. population growth).
Productivity could mean output per unit of labour (per worker).
Technology - e.g. faster broadband.
Infrastructure - e.g. better trains and roads and ports would means goods and services can be produced and transported more efficiently.
Enterprise.
Cultural attitudes - e.g. if in some countries women were permitted to participate in the labour market, this would shift LRAS to the right.
Factor mobility - e.g. the more occupational and geographical mobility there is in an economy, the more the LRAS will shift out.
Economic incentives - e.g. if corporation tax is lowered to attract foreign firms or domestic firms invest more, then the LRAS will shift out.
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How is the equilibrium found on an AS/AD diagram ?
The intersection between the AD and AS curves shows the equilibrium price level and real GDP of the economy.
At a low price level, firms have little incentive to produce, but consumers are willing to buy.
As the price level rises (also known as inflation), AS rises and AD falls until equilibrium is reached.
170
What are the two models for LRAS ?
The Keynesian Long-Run Aggregate Supply curve curves upwards.
The Classical LRAS is vertical
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Describe the Keynesian LRAS
Keynesian economists build models that have an LRAS that curves upwards.
At low quantities of output, there is a lot of spare capacity. Increases in output use up this spare capacity and they are not inflationary. Unemployed workers are hired and unused factors of production are used.
As output rises, supply starts to become a 'limiting factor'. There could be labour shortages, capital shortages or a shortage of raw materials. This is inflationary, but not impossible to increase output.
Eventually, the economy is at Yfull and all factors of production are being used. The economy is at full output.
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Describe the classical LRAS
The Classical LRAS curve is vertical.
In the long run, when all of an economy's factors of production are being used, the economy is operating on its PPF and is at full capacity. An increase in price, cannot incentivise an increase in output, because output in the economy is maxed out.
The Classical LRAS can be shifted by an increase in the amount or quality of each factor of production.
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How might an economy's LRAS curve be shifted outward?
Explain the LRAS
The LRAS represents supply when all factors of production are being utilised at their long-run levels. The most important factor to shift LRAS outwards (to the right) is productivity growth. But it could also be an increase in the amount of factors of production (e.g. population growth). Anything that boosts productivity will, therefore, boost LRAS.
Factor mobility
The more occupational and geographical mobility there is in an economy, the more the LRAS will shift out. HS2 has been seen as a large-scale policy aimed at increasing factor mobility because it would allow workers to take jobs in a much larger area (increasing the pull of skilled labour).
Cultural attitudes
Attitudes towards women can impact the LRAS. If women are excluded from the workplace, the LRAS will be further leftwards, with lower productive output. During WW1 and WW2, women took on many new employment roles, which boosted the LRAS. In some countries, encouraging more women to participate in the labour market would increase the economy's productive output and shift the LRAS rightwards.
174
What does the circular flow of income show ?
This model provides an illustration of the flow of money around an economy.
Firms pay households for their factors of production (labour, land and capital) and households pay firms for goods and services. Income 'flows' in a circle.
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How are the factors of production in the circular flow of income ?
Households own the factors of production that firms need to produce goods and services, so firms pay households to use them.
Labour is paid for in wages.
Land is paid for in rent.
Capital is paid for in interest.
The owner of the firm earns profit. Because the owner is from a household, the profits also go to households as payment for 'enterprise'.
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What is income ?
Income is a flow of money, often measured on a monthly or annual basis.
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What is wealth ?
Wealth is the sum of all assets, including pensions, money in the bank, financial investments, and the value of a home.
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What factors influence the distribution of income/wealth ?
Taxation policy: regressive policies will tend to increase the income and wealth gap between different groups in a country. Progressive taxation policies will reduce the gap.
The differences in wage between low and high skilled labour.
The level of discrimination against different groups of workers.
Regional differences in earnings.
Unsalaried individuals depending on state benefits.
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Enrique Iglesias is estimated to have $100M in stocks, bonds, cash and other real estate assets. How are all of these assets best described?
Wealth
180
What are withdrawals in the circular flow of income ?
Withdrawals refer to flows of money leaving the circular flow of income
181
What are injections in the circular flow of income ?
Injections refer to flows of money into the circular flow of income
182
What are the three withdrawals (also called leakages) from the Circular flow of income ?
Savings (S)
Taxes (T)
Imports (M)
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What are the three injections into the Circular flow of income ?
Exports (X)
Investment (I)
Government Spending (G)
184
If injections = withdrawals, what does this mean for the national economy ?
It will be in equilibrium and there will be no tendency for change
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If injections exceed withdrawals,, then what does this mean for the circular flow of income ?
The circular flow of income will expand. And so national income will rise.
186
If leakages exceed injections, then what does this mean for the circular flow of income ?
The circular flow of income will shrink. And so national income will fall.
187
What is the impact of expansionary fiscal policy in relation to the circular flow of income ?
E.g. if the government decides upon expansionary fiscal policy and increases government spending, this raises injections.
E.g. if injections exceed withdrawals, the circular flow of income will expand and national income will rise.
188
What is the impact of low animal spirits in relation to the circular flow of income ?
E.g. if there is uncertainty (low animal spirits), say, because of the risk of a break up of the European Union (EU), then consumers will save more (savings is a leakage) and firms will invest less (investment is an injection).
So if leakages exceed injections, the circular flow of income will shrink and national income will too.
189
What are important for working out how big the multiplier effect in an economy
Different marginal propensities
Marginal propensity to consume (MPC)
Marginal propensity to save (MPS)
Marginal propensity to tax (MPT)
Marginal propensity to import (MPM)
190
How do you calculate the marginal propensity to consume (MPC) ?
The marginal propensity to consume (MPC) is calculated as the change in C divided by change in income.
The MPC represents the amount of each extra pound that the consumer spends when given an extra pound in income.
191
If the MPC was 0.25 what does this mean ?
If the MPC was 0.25, this means that for each extra pound in income, they spend £0.25.
192
What is the relationship between the marginal propensity to consumer (MPC) and poor countries ?
People who earn less money or live in poorer countries usually have higher MPCs.
193
How is the marginal propensity to save (MPS) is calculated ?
The marginal propensity to save (MPS) is calculated as the change in savings divided by change in income.
194
What does the marginal propensity to save MPS represent ?
The MPS represents the amount of each extra pound that the consumer saves when given an extra pound in income.
195
How is the marginal propensity to tax (MPT) calculated ?
The marginal propensity to tax (MPT) is the change in tax paid divided by the change in income
196
What does the marginal propensity to tax (MPT) represent ?
The MPT represents the amount of each extra pound earned that is spent paying taxes
197
What is the the marginal propensity to tax (MPT) also known as ?
The MPT can also be called the marginal tax rate.
198
How is the marginal propensity to import (MPM) calculated ?
The marginal propensity to import (MPM) is the change in imports purchased divided by the change in income.
For every extra £1 of income, the MPM is the proportion of that £1 spent on imported goods.
199
What is the multiplier effect defined as ?
The multiplier is defined as an initial change in an injection or leakage that leads to a much greater final change in real national income. One person’s consumption is another person’s income
200
How does the multiplier effect work ?
Let's say a government decides to build a new hospital at a cost of £50 billion.
Government spending (G) will rise by £50bn. AD and real GDP will rise by £50bn.
The government will spend £25bn of this money on a construction firm. The firm spends £10bn on investment (I), a component of AD. Investment rises by £10bn.
The firm also spends £5bn on workers who receive higher incomes and spend this – so now consumer spending (C) goes up by £5bn. C is another component of AD.
AD has risen £65bn (£50bn plus £10bn plus £5bn) from an initial £50bn.
So, if spending rises by an initial £50bn, there will be one large rightwards shift in AD. But each stage of the multiplier effect could be viewed to add another small rightwards shift in AD, each of a smaller size than the last.
201
How do you calculate the multiplier effect ?
1/1-MPC
1/MPW
202
The MPC is 0.2 and there’s an initial injection of £10bn what will be the real national income after the multiplier has come into effect ?
1/1-0.2
=1.25
1.25x10bn
An initial injection of £10bn will result in £12.5bn increase in real national income
203
What’s found about MPCs ?
Japelli (1990) found that 20% of the American population was credit-constrained.
Gross & Souleles (2002) found that 2/3 of people responded to automatic increases in their credit card limits by spending more.
Both these studies suggest that the MPC may be high and that the availability of credit (or debt) could be the constraining factor.
204
What is the total change in GDP if the government injects £50m and the multiplier is 1.5?
75m
205
What is the MPW ?
The marginal propensity to withdraw = MPS + MPT + MPM. Savings, taxes, and imports from abroad are all 'withdrawals' from the economy.
Extra earnings are either spent consuming goods or are withdrawn. MPC + MPW = 1. So the Multiplier effect also equals 1/MPW.
206
What does a high MPS do to the multiplier effect ?
A higher MPS will increase the MPW and reduce the size of the multiplier in the economy
207
What does a high MPT do to the multiplier effect ?
A higher MPT will increase the MPW and reduce the size of the multiplier in the economy
208
What does a higher MPM do to the multiplier effect ?
A higher MPM will increase the MPW and reduce the size of the multiplier in the economy.
209
How do you solve the MPW ?
The marginal propensity to withdraw = MPS + MPT + MPM.
210
What is the difference between income and wealth and what factors influence their distribution?
Explain income
Income is a flow of money, often measured on a monthly or annual basis. A wage represents a form of income for example.
Explain wealth
Wealth is the sum of all of someone's assets, including pensions, money in the bank, financial investments, and the value of a home. Wealth, unlike income, does not have to be in a financially liquid form as property, for example, cannot be exchanged in the same way as cash. Very well off people may have no income but a huge portfolio of assets.
Factors impacting distribution
Regressive tax policies will tend to increase the income and wealth gap between different groups in a country. Progressive taxation policies will reduce the gap. Other factors that affect the gaps in income and wealth are the differences in wages between low skilled and high skilled labour and the level of state benefit.
211
What is economic growth ?
Economic growth is a rise in the real value of goods and services being produced in a given period of time
212
How can short run economic growth be measured?
Short run economic growth can be measured by the annual percentage change in real GDP.
It can be shown on an AD/AS diagram by a rightwards shift of Aggregate Demand
213
Ho can long run economic growth be measured ?
Long-run economic growth can be caused by factors that serve to increase the Long Run Aggregate Supply:
An increase in the quantity of factors of production e.g. more labour from immigration.
An increase in capital for higher investment from firms e.g. because of lower corporation taxes.
An increase in the quality of the factors of production e.g. better training and education programmes, more investment in research and development, improvements in productivity of the factors of production.
214
What are two ways economic growth is measured and compared ?
Actual economic growth
Potential economic growth
215
What is actual economic growth ?
Actual:
The % increase every year in GDP.
Driven by rising AD.
216
What is potential economic growth ?
Potential:
How much the economy could grow.
National output if the economy was operating at full employment.
217
What are causes of short run economic growth ?
Anything that causes Aggregate Demand to rise (discussed in the AD section), will cause short-run economic growth.
The components are Consumption, Investment, Government Spending, Exports and Imports.
Apart from imports, if any of these components of aggregate demand rise, so will short-run economic growth.
Because imports are a leakage, and the money goes abroad, this component have to fall to raise Aggregate Demand.
218
What is export led growth ?
Economic growth can be led by selling more exports to foreign countries.
This improves the net trade component of AD.
China is a very good example of an economy that has grown through exports.
Export-led growth is considered a good way for developing countries to establish themselves.
219
What’s an output gap ?
An output gap is present when there is a difference between the actual level of real GDP in an economy and the potential level of real GDP (when all factors of production are fully employed)
220
What is a positive output gap ?
A positive output gap is defined as: “when the actual level of real GDP is greater than the potential underlying level of real GDP”.
Positive output gaps mean that an economy is temporarily producing beyond its productive potential. This is only possible for a short time, and leads to workers being paid overtime, and workers and machines being over-used. This causes inflationary pressure as wages and costs rise.
221
What is a negative output gap ?
A negative output gap is defined as: “when the actual level of real GDP is less than the potential underlying level of real GDP”.
Negative output gaps means there is 'spare capacity'. So there will be unemployment (demand-deficient), and demand-pull inflationary pressure will be low because there are lots of resources and factors of production not being used.
222
The economic cycle is the natural fluctuation of the economy between what ?
between recovery and recession
223
What is the economic cycle ?
Recession
Recovery
Boom
Stagnation
Return to recession
224
In the economic cycle what happens during the recession stage ?
A recession is defined as “two or more consecutive quarters of negative real GDP growth”.
In the trough, the prices of factors of production, such as labour and land, have fallen so far that some entrepreneurs think the only way is up. So some entrepreneurs think the economy has ‘bottomed out’ and it is the best time to buy and invest.
This starts the recovery process...
225
In the economic cycle what happens during the recovery stage ?
Eventually, this recovery gathers momentum and turns into a full expansion:
As investment increases, real GDP grows. Unemployment falls as jobs are created and workers are needed to produce goods and services.
So incomes rise and consumption rises too, creating a further need for investment and workers. As consumers buy more things like houses, house prices also begin to rise.
As profits rise, so do firm’s share prices. Animal spirits (confidence) are rising with these variables too.
226
In the economic cycle what happens during the boom stage ?
During a boom:
Workers are working over-time and wages are rising.
Inwards migration may rise attracted by the work.
Demand for luxury goods is high.
Demand for imports is high – raw materials to produce other goods and luxury goods from abroad to consume e.g. holidays abroad.
Eventually, factories can't keep up with demand and so there are delays in deliveries. Workers keep working overtime, extra staff are hired.
The government gets more tax revenue and is spending less on benefits, so the fiscal deficit reduces.
227
In the economic cycle what happens during the stagnation stage ?
Once the boom is in full flow, eventually it starts to become unsustainable. People start to worry that house prices and share prices are too high. They no longer reflect the real value of these assets but instead are speculative bubbles (over optimistic hype).
Some firms have over-invested as a result and returns on their investment starts to be below forecast. Suddenly, some entrepreneurs get cold feet and start to worry. They might start to put off investment projects. Some workers may be told to take shorter shifts
228
In the economic cycle what happens during the return to recession stage ?
If prices start to fall significantly, firms profits will fall as demand collapses. Now, workers will be fired and unemployment will rise. Government spending on welfare will rise while tax revenue from firms and consumers will fall.
Consumers may try to save money for a rainy day, reducing consumption further.
As firms profits fall, some make losses and go bankrupt. This means some banks have made loans that don’t get repaid. This harms confidence and reduces aggregate demand. Firms will need fewer workers and will reduce investment further.
And the cycle repeats.
229
What are some causes of recessions ?
Global financial crisis
A global financial crisis e.g. 2008, could cause a boom to turn into a recession.
Agricultural harvest
A bad harvest for an agricultural based economy could trigger or prolong a recession
Trading partners
A recession in a main trading partner e.g. a recession in the EU would cause exports to fall from the UK, which could trigger a change from slowdown to recession.
230
What are the dangers of economic growth ?
Environmental concerns: growth can give rise to negative externalities, such as pollution.
Unsustainable: growth at the expense of future generations by using up natural resources, such as minerals.
Wealth and income inequality: rapid growth can benefit cities more than rural areas, or more skilled workers who have negotiating power with wages.
Inflation: rapid growth can put pressure on resources and lead to prices rising too quickly (inflation).
231
What are the benefits of economic growth ?
Rising incomes leads to better living standards.
Better job prospects.
Less unemployment.
Affordability of goods and services.
Better access to healthcare and education.
Higher tax revenue (“the fiscal dividend”), which can be spent on merit goods such as hospitals and schools, as well as public goods such as infrastructure.
Higher international competitiveness.
232
Who is a very good example of an economy that has grown via exporting goods and services to the rest of the world ?
China
233
Is economic growth always desirable?
Explain economic growth
Economic growth is a rise in the real value of goods and services being produced in a given period of time. Anything that causes a component of AD to rise will cause short-term economic growth, apart from imported goods. Long-run economic growth can be caused by factors that serve to increase the Long Run Aggregate Supply.
Growth is desirable
There are many positives to growth. Growth has the potential to make everyone better off without making anyone worse off. The government benefits from a fiscal dividend due to higher tax revenues. There is lower unemployment associated with growth, higher living standards, and improved international competitiveness.
Growth is not desirable
However, growth at the expense of future generations is considered bad because it is not sustainable to use up natural resources in the present. Growth may also have inflationary impacts where prices rise and the economy has exhausted all the factors of production.
Evaluate
The desirability of economic growth depends on many things. Growth is more desirable if it represents increases in the productive capacity of the economy because this is not associated with price rises. It also depends on how growth is distributed, what the causes behind it are, and whether it is sustainable.
