Economics unit 2

revision

National Economic Performance• 4 key variables: economic growth, low inflation (2%), low unemployment,

current account.• Trade offs are when the govt. cant achieve all at once, eg. Fast economic

growth tends worsen the balance of payments o the current account because uk consumers buy more imported goods with their higher incomes.

Circular Flow Of Income• GDP is the measure of national income.• Households supply land, labour, capital to firms in return for rents, wages,

interests and profits. The households then use this money to buy goods and services from firms. This is called the circular flow of income.

• There are injections (investment, government spending and exports)• And withdrawals (savings, taxes and imports)• National income is the measure of the countries output. • An example of a transfer payment is an individual sells a 2nd hand car but

no new car is created. These are not included on the final calculation of national income.

• GDP can be used to compare between countries but also over time.

Economic Growth• Increases in productive capacity is known as economic growth.• UK economy is growing at 2.5% per annum.• A business cycle is a series of fluctuations within an economy. Tends to

have a peak/boom (GDP is growing fast), a downturn (economy is slowing down), recession/slump/depression (GDP may be close to or at 0) and recovery (GDP starts to pick up again)

• The output gap can be positive or negative and it is when there is a difference between actual level of GDP and its estimated long term value.

• Economic growth occurs when there is an increase in quality or quantity of the inputs into the production process or they are use more efficiently. Eg increasing number of workers, or technological advances, or increased competitions forces greater efficiency. Output gap

Economic Growth And Welfare• GDP is a measure of living standards• But many other factors contribute to welfare of individuals, political

freedom, freedom from fear of violence (if a person doesn’t feel safe then their welfare wont be optimal) and the environment are some examples.

• Benefits of growth include life expectancy which has doubled over last 300 years, enough food and drink, improved housing standards, increased literacy rates.

• But there are arguments against growth, these include negative externalities because crime and stress levels have increased, some say growth is unsustainable, more resources will have to be used which will cause huge problems.

Economics Of Happiness• The economics of happiness investigates exactly what contributes to

welfare and attempts to put values on some of these factors. • For example being married is worth £68400 a year and being disabled is

worth -61000 a year.

Employment And Unemployment• Employment is the total number of people with a job and unemployment

is the opposite. • Employment changes due to man factors which include size of population,

activity rate (proportion of population either in work or unemployed), and net migration.

• There are 4 different types of unemployment, 1. frictional (lose their jobs but quickly move on to another job) 2. seasonal (some jobs work on a seasonal basis eg. Ski instructor) 3. structural (demand < supply, eg. Coal miners dotn have work because the demand for coal is no longer) 4. cyclical (insufficient AD in an economy, when an economy moves from boom to recession)

• Costs of unemployment include monetary costs to individuals and dependants, costs to taxpayers, cost to economy.

Inflation 1• Defined as a sustained general rise in prices, deflation is a fall in price

levels.• Inflation is measured using CPI (consumer price index) every month prices

are recorded in a basket of goods across the country and are the converted into index form. The items are weighted (because larger income is spent on food than tobacco) They are then compared to last months data and inflation is calculated.

• Any price index is a weighted average, each individual household will have a different rate of inflation (eg. Pensioner and student will but different things)

• Causes of inflation are demand-pull (when AD rises with no increase in AS eg. Consumer spending will rise excessively due to low interest rates) and cost-push (because of rising costs eg. Imports rise in costs, or increased profit margins, or raise indirect taxes)

Inflation 2• Costs of inflation include shoe leather costs which is the amount of time

and effort a person puts into trying to counter act the effects of inflation, some also say it causes unemployment and lowers growth, inflation increases costs of production and creates uncertainty, this lowers the profitability which means investment will be more risky so lower investment = unemployment.

Balance Of Payments• Record of all financial dealings between a country and all other countries.• The current account, trade in goods is often called trade in visibles and

trade in services is in invisibles. The current balance is the difference between exports and imports.

• A current account surplus is when exports > imports• Current account deficit is when imports > exports, so more money is being

spent.• Many things cause a change in current account, these include change in

exchange rates, AD may change in economy or world economy.• A current account deficit is only a problem when it cannot be funded and

whether it has a significant impact on the economy. • China run a current account surplus, this can be when a country is

planning a long term structural change. But it can cause friction between countries.

Measures Of Development• HDI is the human development measure. It measures life expectancy,

education and GDP per capita. • GDP is not adequate to measure of welfare or happiness for a society.

Economics development today tends to be defined in terms of freedom and lack of freedom. Eg. Lack of freedom when they cant afford enough to eat.

Consumption and Saving• Consumption in economics is spending on consumer goods and services

eg. Buying a chocolate bar. • Durable goods are goods which last a long time eg. car whereas non-

durable goods are used up immediately eg. Ice cream• Saving is what is not spent out of income. • Average propensity to save is the proportion of income that is saved• Average propensity to consume is the proportion of income that is spent

on consumption.• The wealth effect is the change in consumption following a change in

wealth

Investment• Investment is the addition of capital stock to the economy. Buying shares

in a new company would be saving but buying new equipment for a company would be investment.

• Investment tends to rise when interest rates fall.• Many factors affect the planned investment, these include tech changes

(will make new capital equipment more productive than previous equipment), cost of capital goods and confidence levels to name a few.

• 70% of investment is from retained profits.

Government Spending, Exports and Imports.

• Government announce changes in spending during their budgets• When government spending > taxation = budget surplus• When taxation > government spending = budget deficit• Exports are goods and services sold to foreigners and imports are goods

and services bought from foreigners.• Demand for X and M are influenced by things like price, exchange rate (if

the pound rises then it will cost foreigners to more to buy, so then exports may decrease), and also non price factors (things like quality or unique patents)

Aggregate Demand• Aggregate demand is the total demand in the economy• Made up for C+I+G+(X-M). Consumption + Investment + Government

spending = (eXports – iMports)• As incomes rise, households spend more so consumption will increase• As interest rates decrease investment will decrease due to availability to

borrow money at cheap prices.• Factors that may influence the exports and imports include the exchange

rate and also the relative prices of goods across the world. • The multiplier effect is when there is an injection into extra income that

means an injection in more spending and so forth.• The curve is downward sloping because when general level of prices is low

then spending power of income is higher.

Aggregate Supply• Aggregate supply shows the level of output in the whole economy• In the short run firms have little flexibility so to expand output they have

to pay overtime to existing workers. • Factors that will influence the AS include the quantity of input eg. Money,

labour force, the efficiency of the workers, and the costs faced by firms. • Long run AD shows the productive potential of the economy and the level

of full capacity. • Factors that can shift the LRAS curve include education training, tech

advances, investment. • The Keynesian LRAS curve is a different theory of AS, Keynes argues that

there have been times when the markets haven't cleared for long periods of time.

Equilibrium output• When you bring AD and AS together you can find the equilibrium output

point. • Equilibrium output in the short run looks like this.• Any increase will shift AD or AS to the right

• Equilibrium output in the long run looks like this. • An increase in LRAS means there has been economic growth.

Fiscal Policy• A demand side policy• Use of government spending, taxation and borrowing to manipulate the

demand in the economy.• Budget deficit is when the govt. spends more than it receives in taxes.• A budget surplus is the opposite• expansionary fiscal policy is when the govt. lower tax and increase

spending.• Deflationary fiscal policy is the vice versa.• The diagrams are the same as demand and supply but affect demand shift

left or right.

Supply side policies• Designed to increase average rate of growth in an economy.• There are 18 policies.• Labour market policies are policies that affect quantity and quality of

workers, eg. Education and training will improve quality of workers but will have a long time lag, another is if the government make moving jobs as easy as possible which will decrease unemployment.

• Capital market policies increase the capital stock of the economy, eg. Reducing taxes on company profits so therefore they are more likely to invest thus increasing AS.

• Good market policies include encouraging free trade which will force current firms to increase efficiency and will also create competition.

• Many supply side policies will affect AD, eg. Reduced unemployment creates greater confidence which will lead to investment.

Monetary policy• Demand side policy using monetary instruments, eg. Interest rates.• If interest rates are low = more borrowing = more investment = increase in AD• If interest rates are high = more saving = less investment/borrowing. • Policy objectives include controlling inflation, if interest rates are high then

less money will be invested and AD will decrease, thus causing deflation and vice versa for inflation.

• Unemployment can be controlled because an increase in investment caused by low interest rates = more people taken on and vice versa.

• Economics growth can be manipulated by investment also.• Current balance, higher interest rates lead to lower AD, reduces imports and

improves current account balance. Higher interest rates = raise in value of currency.

• Trade offs include short term rise in interest rates can reduce inflation but might increase unemplyment.

Exchange Rate Policy• Determined by demand and supply.• Can be influenced by interest rates. Increased rates = increased value of

pound. Shown by shift to right in AD and shift to left in AS so higher equilibrium point.

• A rise in value of currency will reduce exports and increase imports. And vice versa.

• Raising exchange rate can benefit inflation but will tend to reduce output, increase unemployment and lead to deterioration in the current account. A fall in exchange rate is likely to increase both inflation and output, reduce unemployment and lead to an improvement in the current account.