unit 2 economics proper

8/9/2019 Unit 2 Economics Proper

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OCR

Unit 2


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EconomicsRevision

Judah Chandra____

Economics Revision

KEY TERMS

Economic growth - in the short

run, an increase in rea !"#, and inthe on$ run, an increase in

%roductive ca%acit&, that is, in the

ma'imum out%ut that the econom& can

%roduce(


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Unemployment - a situation *here

%eo%e are out o+ *or ut are *iin$ and ae to *or(

Infation- a sustained rise in the %rice eve. the %ercenta$e increase in

the %rice eve over a %eriod o+ time(

Gross domestic product (GDP)- the tota out%ut o+ $oods and services

%roduced in a countr&

Aggregate demand (AD)- the tota demand +or a countr&/s $oods and

services at a $iven %rice eve and in a $iven time %eriod(

Aggregate demand (AS)- the tota amount that %roducers in an

econom& are *iin$ and ae to su%%& at a $iven %rice eve in a $iven

time %eriod(

Multiplier eect - the %rocess & *hich an& chan$e in a com%onent o+

a$$re$ate demand resuts in a $reater 0na chan$e in rea !"#(

Supply!side policies - %oicies desi$ned to increase a$$re$ate su%%& &

im%rovin$ the ecienc& o+ aour and %roduct marets(

Monetary policy - centra an andor $overnment decisions on the rate

o+ interest, the mone& su%%& and the e'chan$e rate(

"iscal policy - the ta'ation and s%endin$ decisions o+ a $overnment(

Aggregate demand (AD)The com%onents o+ a$$re$ate demand - s%endin$ & househods on $oods

and services

- 3nvestment

- S%endin$ on ca%ita $oods 4machines, oceuidin$s5

AD = C + I + G (X - M)


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- !overnment s%endin$

- 7et e'%orts add +orei$ner

Consumer expenditure ! real disposa#le income, this

is the main in8uence on

consumer e'%enditure- $ealth, the more %eo%e have 4savin$s and

shares5 the more the& tend to s%end

- %onsumer con&dence, ho* o%timistic

consumers are aout +uture economic

%ros%ects(

Investment ! %hanges in real disposa#le income,

this ma& encoura$e 0rms to e'%and their

ca%acit&(

- %apacity utilisation, 0rms are aso moreie& to invest i+ the& are current& o%eratin$

cose to +u ca%acit&(

- %orporation ta', a cut in cor%oration ta'

increases the amount o+ %ro0t 0rms can ee%

and so can resut in an increase in

investment(

- he rate o interest, a rise in the rate o+

interest *oud e ie& to reduce

investment(

- Ad*ances in technology, a 0rm ma& u&ne* ca%ita e9ui%ment i+ it thins that it *i

%roduce etter 9uait& %roducts or %roduce

%roducts more chea%&(

Government spending!The $overnments vie* on the e'tent o+

maret +aiure and its aiit& to correct it(

- The eve o+ economic activit& in the

econom& can in8uence $overnment

s%endin$ 4eve o+ unem%o&ment in a certain

area5

Net exports! +eal disposa#le income a#road, a risein income aoard is ie& to resut in more

e'%orts ein$ sod(

- +eal disposa#le income at home, a rise in

income at home ma& resut in a +a in

e'%orts(

- he e'change rate, the %rice o+ one

currenc& in terms o+ another currenc&(

Shits in AD Shi+t ri$ht Shi+t e+t

Chan$es in $overnment%oic&

a +a in the interestrate

: rise in the interest rate


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.#-ecti*es o go*ernment economic policyPositi*e and sta#le Economic growth,

- increasin$ materia ivin$ standards

- Trend $ro*th, the e'%ected increase in %otentia out%ut

over time( 3t is a measure o+ ho* +ast the econom& can

$ro* *ithout $eneratin$ in8ation(- This means avoidin$ de%etin$ non-rene*ae resources

and dama$in$ the environment, aso to reduce %oution

and searchin$ +or ceaner sources o+ ener$&(

/igh Employment and low unemployment,

! /igh employment and low unemployment0

- o* eve in8ation enae 0rms to reduce their costs &

not raisin$ *a$es in ine *ith in8ation rather than &

main$ some *ored redundant

"a*oura#le 2alance o payments,

- Current account de0cit, *hen mone& is eavin$ the

countr& than enterin$ it(

- : $overnment is sti ie& to *ant to see increase in

the internationa com%etitiveness o+ its %roducers, in

order to ee% a$$re$ate demand and out%ut hi$h in the

econom&(

Economic sta#ility,

- !overnments *ant to avoid si$ni0cant 8uctuations in

the econom&( 7o ABoom and ust


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Economic Growth- in the short run, an increase in rea !"#, and in the on$ run, an

increase in %roductive ca%acit&, that is, in the ma'imum out%ut

that the econom& can %roduce(

Measuring economic growth,

- measured & the annua %ercenta$e chan$e in rea !"#

he causes o economic growth,

- a +a in e'chan$e rate

- a cut in income ta' or a rise in consumer con0dence

- The essentia causes o+ on$-run economic $ro*th are

increases in the 9uantit& andor 9uait& o+ resources(

- :nd econom&/s resources ma& e increased as a resut o+

the sie o+ the aour +orce risin$(

- The main cause is advances in technoo$& and im%rovement

in education and trainin$(

he costs o economic growth,

- The on& *a& it can increase its out%ut is to s*itch resources

+rom main$ consumer $oods to main$ ca%ita $oods(

- 3+ economic $ro*th is achieved in a *a& that is notsustainae, *ithout re$ard to contros on %oution, there

*i e dama$e to the environment(

- There is aso ris that economic $ro*th ma& resut in the

de%etion o+ non-rene*ae resources(

- Economic $ro*th ma& reduce the 9uait& o+ some %eo%e/s

ives(

he #ene&ts o economic growth,

- : rise in %eo%es materia standard o+ ivin$,- 3+ rea !"# %er head rises, the %o%uation can enFo& more

$oods and services(

- Economic $ro*th enaes %overt& *ithin a countr& to e

reduced(

- @i$her out%ut raises ta' revenue *ithout havin$ to increase

ta' rates(

- Economic $ro*th increases em%o&ment

he sustaina#ility o economic growth,


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- Sustainae economic $ro*th, economic $ro*th that can

continue over time and does not endan$er +uture

$enerations(

- This means avoidin$ de%etin$ non-rene*ae resources and

dama$in$ the environment, aso to reduce %oution andsearchin$ +or ceaner sources o+ ener$&(

Unemployment: situation *here %eo%e are out o+ *or ut are *iin$

and ae to *or(

Measuring unemployment,

- Unem%o&ment rate, the %ercenta$e o+ the aour *ho are

out o+ *or(

- The $overnment/s %re+erred measure is *hat is no*n asthe >aour O de0nition o+ unem%o&ment(

Di3culties o measuring unemployment,

- >aour +orce surve&4>O de0nition o+

unem%o&ment(

- Some %eo%e can e active& seein$ *or ut not entited

to caim unem%o&ment-reated ene0ts(

- >


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- 3nternationa unem%o&ment, occurs *hen Fos are ost

ecause 0rms decide to carr& out some o+ their *or

aroad(

- ost out%ut, havin$ %eo%e *ho are *iin$ and ae to *or

*ithout Fos is a *aste o+ resources

- >ost ta' revenue, i+ more %eo%e *ere in *or, incomes,

s%endin$ and %ossi& %ro0ts *oud e hi$her(

- !overnment s%endin$ on unem%o&ment ene0ts, i+

unem%o&ment rises, the $overnment *i have to s%end

more on unem%o&ment reated ene0ts(

- #ressure on other +orms, *hen %eo%e are unem%o&ed the&

are more ie& to suIer heath %roems and even increase

crime(

- @&steresis, the on$er %eo%e are out o+ *or, the more

dicut it can e +or them to $ain another Fo(

he #ene&ts o unemployment,

- 3t ma& $ive them time to search +or a more re*ardin$ Fo(

- : hi$h eve o+ unem%o&ment ma& discoura$e *orers +rom

seein$ *a$e rises and ma& dissuade them +rom tain$industria action(

he signi&cance o unemployment,

- @o* si$ni0cant the conse9uences o+ unem%o&ment are

de%ends on ho* much unem%o&ment there is, ho* on$ on

avera$e %eo%e are unem%o&ed, the ene0ts %rovided to

the unem%o&ment, the t&%e o+ em%o&ment and the

distriution o+ unem%o&ment(

- The hi$her the rate o+ unem%o&ment, the more serious thecosts are ie& to e

- !enerous unem%o&ment ene0ts reduce the costs o+

unem%o&ment ut the& have an o%%ortunit& cost +or the

econom&(

Infation: sustained rise in %rice eve. the %ercenta$e increase in the %rice eve

over a %eriod o+ time(

Measuring infation,


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- Consumer %rice inde' 4C#35, a measure o+ chan$es in the

%rice o+ a re%resentative aset o+ consumer $oods and

services(

- Retai %rice inde' 4R#35, measure o+ in8ation that is used +or

adFustin$ %ensions and other ene0ts to tae account o+chan$es in in8ation and +re9uent& used in *a$e

ne$otiations(

Di3culties o measuring infation,

- Measures o+ in8ation aso tend to overstate in8ation, as the&

measure the %rice o+ a 0'ed aset o+ %roducts(

- The measures do not tae into account %eo%e/s aiit& to

ater *hat the& u& durin$ the &ear(

- #eo%e usua& move a*a& +rom u&in$ %roducts that are

ecomin$ reative& more e'%ensive to*ards those that are

ecomin$ reative& chea%er(

he causes o infation,

- "emand-%u in8ation, increases in the %rice eve caused &

increase in a$$re$ate demand(

- Cost-%ush in8ation, increases in the %rice eve caused &

increases in the costs o+ %roduction(

he conse4uences o infation,

-


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- Uncertaint&, i+ 0rms are uncertain aout *hat their costs *i

e and *hat %rices the& *i receive +rom sein$ their

%roducts, the& ma& e reuctant to invest(

he #ene&ts o infation,- orers aso ie rises in their %a&, even i+ these are

matched & hi$her %rices(

- The aiit& that in8ation $ives 0rms too ater *orers/ rea

%a& can he% aour marets o%erate more ecient& and

reduce unem%o&ment(

DE"1AI.5 - a sustained +a in the $enera %rice eve(

he signi&cance o infation,

- Cost-push in!tiontends to e more harm+u +or an

econom& than demand-%u in8ation. cost-%ush is o+ten

accom%anied & a +a in rea !"#(

- "i#h in!tionma& mean that %rices are chan$in$ so o+ten

that 0rms cannot %uish %rices(

- Fluctuating infationcan e destaiisin$ as, a$ain, it

creates in8ationar& noise and that it maes it dicut +or the

$overnment, 0rms and househods to %an ahead(

- Unanticipated infation, a situation *here %eo%e are

sur%rised & the in8ation rate( Unantici%ated in8ation

causes uncertaint& and can resut in a random redistriutiono+ income(

2alance o payments: record o+ mone& 8o*s comin$ in and $oin$ out o+ a countr&(

%urrent account de&cit,*hen more mone& is eavin$ the countr& than

enterin$ it, as resut o+ saes o+ its e'%orts, income and current

trans+ers +rom aroad ein$ ess than im%orts and income and current

trans+ers $oin$ aroad

he structure o the current account o the #alance o payments,

! The main eements o+ the aance o+ %a&ments are the

current account, the ca%ita and 0nancia accounts and net

errors and omissions(

! The current account incudes trades in $oods, trade in

services, income and trans+ers( Trade in $oods records the

earnin$s +rom e'%orts and the e'%enditure on im%orts o+

$oods(


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! The income %art o+ the current account covers ar$e&

investment income(

! Trans+ers cover the trans+er o+ mone& made and received &

the $overnment and individuas(

! The ca%ita and 0nancia accounts sho* the movement o+direct investment(

! 7et errors and omissions, is added to ensure that the

aance o+ %a&ments does aance(

he causes o a de&cit on the current account,

! : de0cit on the current occurs *hen the countr&/s

e'%enditure aroad e'ceeds its revenue +rom aroad(

! Main reasons *h& these ha%%en, 415 ecause the countr&/s

inhaitants have s%ent more on $oods and services +rom

aroad than overseas( 425 Because there has een a net

out8o* o+ investment income(

! : rise in the e'chan$e rate ma& aso resut in a de0cit, as it

*i raise e'%orts %rices and o*er im%ort maret(

! : de0cit caused & chan$es in income(

he causes o a surplus on the current account,

! : sur%us on the current account is e'%erienced *hen acountr&/s revenue +rom aroad is $reater than it/s

e'%enditure

! The countr& is more ie& to have a sur%us i+ it/s %roducts

are o+ a hi$h 9uait&, are %roduced at a o* cost and re8ect

*hat househods and 0rms at home and aroad to u&(

he conse4uences o a de&cit and a surplus on the

%urrent account o the #alance o payments0

- : de0cit means that a countr& is consumin$ more than it is%roducin$(

- 3+ de0cit increase, it *i reduce :" in the econom&(

- : sur%us means a countr& is consumin$ ess than it is

%roducin$ and is e'%eriencin$ a net in8o* o+ mone& and

income(

- The increase in the mone& su%%& *i mean that ans *i

have more mone&, *hich can increase an eadin$(

- : rise in a sur%us *i mean that net e'%orts are increasin$(

This *i rise :" and e ie& to %ush u% the e'chan$e rate(


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he signi&cance o a current account de&cit0

! : de0cit that +orms a sma %ercenta$e o+ rea !"# or one

that asts a short time is unie& to e ver& si$ni0cant

! : de0cit ma& indicate a $ro*in$ and, indeed, heath&

econom&, or it ma& indicate an econom& *ith structura%roems(

! 3+ the out%ut o+ the econom& is increasin$, more +orei$n ra*

materias *i e ou$ht & 0rms and the hi$her income

ma& resut in more im%orts o+ 0nished $oods(

! an econom& *ith a hi$h in8ation rate and o* %roductivit& is

aso ie& to have a de0cit(

Supply!side policy

- Su%%&-side %oicies are %oicies desi$ned to increase :S &im%rovin$ the ecienc& o+ aour and %roduct marets(

+anges o supply!side policies,

- These tr& to o*er 0rms/ costs o+ %roduction and increase

%roductive ca%acit& & increasin$ the ecienc& o+ aour

and %roduct marets(

- Su%%&-side %oicies o+ten aim to raise macroeconomic

%er+ormance & im%rovin$ the %er+ormance o+ %articuar

marets(

E'amples o supply!side policies,

- Education and trainin$, $overnment investment in education

and trainin$ and $overnment encoura$ement to 0rms to

increase their trainin$ shoud raise in the aour and aour

%roductivit&(

- !overnment to ne* 0rms, sma 0rms %rovide em%o&ment,

deveo% entre%reneuria sis and introduce ne* ideas(

- Reduction in direct ta'es, o*er direct ta'es increases

incentives to 0rms, *orers and %otentia *orers( E($( a cut

in cor%oration ta' *i increase oth +unds and investment

and a cut in income ta'(

- Reduction in unem%o&ment ene0ts, a reduction in Fo

seeer/s ao*ance *i *iden the $a% et*een income +rom

em%o&ment and the ene0t(

- #rivatisation, trans+er o+ assets +rom the %uic to the

%rivate sector( The& eieve that %rivate sector 0rms are in

the est %osition to mae decisions aout *hat to %roduce,

ho* to %roduce and *hat to char$e(


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- "ere$uation, is the remova o+ rues and re$uations that

aIect 0rms in the eie+ that it *i $ive the 0rms $reater

+reedom to mae their o*n decisions and to increase

com%etition & main$ it easier +or ne* 0rms(

he eecti*eness o supply!side policies,

- Su%%&-side %oicies are seective, tar$eted at %articuar

marets, and are desi$ned to raise ecienc&(

- 3ncreasin$ :S enaes :" to continue to rise over time

*ithout in8ationar& %ressures uidin$ u%(

- : hi$her 9uait& o+ resources shoud aso mae domestic

0rms more %rice and 9uait& com%etive(

- 3ncreasin$ the %roductive %otentia o+ an econom& on its

o*n(

Monetary policyCentra an andor $overnment decisions on the rate o+ interest, the

mone& su%%& and the e'chan$e rate( The main aim o+ monetar& %oic& is

to he% ee% macroeconomic staiit& in the econom& and aso to maintain

the vaue o+ mone&(

- The main monetar& %oic& instrument is the rate o+ interest(

- : hi$her interest rate tends to reduce consum%tion and

o*er 0rms/ investment(

- This rise in demand +or %ounds *i %ush u% the vaue o+ the

%ound(

- : hi$her e'chan$e rate *i mae e'%orts more e'%ensive

and im%orts chea%er(

- : rise in the interest rate is ie& to decrease :" &

reducin$ consum%tion, investment and e'%orts minus

im%orts(

- Chan$es in the mone& su%%& can aso e used to in8uence

:"(

- :n increase in the mone& su%%& is ie& to increase :"(

- 3+ the $overnment %rints more mone& or maes it easier +or

ans to end more mone&( #eo%e *i have more mone& to

s%end(

- : rise in the mone& su%%&, & increasin$ the amount that

ans have to end, reduced the interest rate(

he monetary policy committee,

The Monetar& #oic& Committee 4M#C5 o+ the an o+ En$and sets the rate

o+ interest *ith the main oFective o+ achievin$ the $overnment/s tar$etannua rate i+ in8ation o+ 2L, as measured & the C#3(


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he eecti*eness o monetary policy,

- Monetar& %oic& can e dicut to contro(

- : centra an can see to in8uence the e'chan$e rate &

u&in$ and sein$ currenc& and & chan$in$ the interestrate(

- 3nterest rates oIered to savers and char$ed to orro*ers &

commercia ans and other 0nancia institutions do not

a*a&s adFust 9uic& to re8ect to chan$e in ase rate(

- : rise in interest rate ma& not cause to reduce their

s%endin$ and 0rms to ater their investment i+ the& are

o%timistic aout the +uture(

- : centra an/s aiit& to chan$e its interest rate ma& e

imited & the need +or it to remain in ine *ith other

countries/ interest rates(

- :nother imit *ith usin$ interest rate chan$es is that *hen

the interest rate +as to ver& o* eves, a +urther cut is ie&

to e ineIective in stimuatin$ economic activit&(

- The eIectiveness o+ interest rate chan$es to stimuate

economic activit& can e imited & their ver& success in

tacin$ in8ation(

- The eIects o+ monetar& %oic& tend to e more

concentrated on certain $rou%s than do chan$es in income

ta', +or e'am%e(

"iscal policyThe ta'ation and s%endin$ decisions o+ a $overnment(

he nature o &scal policy,

- : $overnment ma& see to in8uence :" and to ensure that

it matches :S and so avoid oth unem%o&ment and

in8ation(

- :utomatic staiisers, +orms o+ $overnment s%endin$ and

ta'ation that chan$e automatica& to oIset 8uctuations in

economic activit&(

- The $overnment *i receive more income ta' revenue *hen

!"# rises(

- Economic c&ce, the tendenc& +or economic activit& to

8uctuate outside its trend $ro*th rate, movin$ +rom a hi$h

eve o+ economic $ro*th e($( +or instance, s%endin$ on chid

ene0t is not ined to the economic c&ce(


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International trade3nternationa trade 3nvoves the e'chan$e o+ $oods and services across

nationa orders(

Ad*antages,- 3t enaes the countr& to s%eciaise as the %roducts it does

not %roduce it can im%ort(

- Consumer can ene0t +rom the o*er %rices and hi$her

9uait& those resuts +rom the hi$her eve o+ com%etition

that arises +rom countries tradin$ internationa&(

- The& can aso enFo& a $reater variet& o+ %roducts(

- The& *i have access to ar$er marets in *hich to se their

%roducts and +rom *hich to u& ra* materias(

Disad*antages,

- Some countries restrict e'%orts and most im%ose

restrictions on im%orts(

- Com%etition

- Occu%ationa immoiit& o+ aour, dicut& in movin$ +rom

one t&%e o+ Fo to another(

Methods o protection

- #rotectionism, the %rotection o+ domestic industries +rom

+orei$n com%etition(

- TariIs, a ta' on im%orts( The& can e im%osed *ith the

intention o+ raisin$ revenue andor discoura$in$ domestic

consumers +rom u&in$ im%orted %roducts(

- Nuotas, a imit on im%orts( The eIect on 9uotas is to reduce

su%%&( This is ie& to %ush u% %rice(


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./E+ P.1I%IES

Policies to reduce unemployment,

- "emand-side %oicies, unem%o&ment na& e

reduced & increases in :"( Usin$ 0sca %oic&coud increase its s%endin$ andor cut ta' rates

in order to rise :"(

- 3ncreases in the mone& su%%& or o*er interest

rates are aso ie& to rise :"(

- Economic staiit& and o* in8ation *i mae

o* unem%o&ment more ie&, & encoura$in$

investment and maintainin$ or increasin$

internationa com%etitiveness(Policies to control infation,

- Cost-%ush in8ation, i+ a $overnment eieves

that in8ation is caused & e'cessive increases in

*a$e rates, it ma& tr& to restrict *a$e rises(

- : $overnment ma& tr& to o*er 0rms/ costs &

reducin$ cor%oration ta'(

- "emand-%u in8ation, these are ones that seeto reduce in8ation & decreasin$ :"

- : hi$her interest rate is ie& to reduce :" &

reducin$ consum%tion, investment and net

e'%orts(

- 3n8ation tar$etin$, i+ %eo%e are convinced that

a centra an has the determination,

e'%erience and aiit& to meet its tar$et, the&

*i act in a *a& that does not cause in8ation(

- >on$ run, a $overnment is ie& to see to

reduce the %ossiiit& o+ in8ationar& %ressure &

increasin$ :S(

Policies to promote economic growth,


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- Short run, increases in :" in the short run occur

due to increases in :" i+ the econom& is initia&

%roducin$ eo* +u ca%acit&(

- >on$ run, increases in the countr&/s out%ut cancontinue to e achieved on& i+ the %roductive

ca%acit& o+ the econom& increases( So +or this to

ha%%en the 9uait& andor 9uantit& o+ resources

have to increase 4su%%&-side %oices tr& to do5(

- Stae $ro*th, most $overnments aim to stae

$ro*th( !overnments tr& to avoid :" increasin$

+aster than the trend $ro*th rate %ermits(

Policies to impro*e the #alance o payments,

! Short run, three main *a&s to tr& to raise e'%ort

revenue and reduce im%ort e'%enditure( : +a in

the e'chan$e rate, reducin$ demand +or a

%roducts(

! E'chan$e rate adFustment, a countr& ma& seeto reduce the e'chan$e rate i+ it eieves that

its current eve is too hi$h and as a resut is

causin$ its %roducts to e uncom%etitive a$ainst

riva countries/ %roducts( o*erin$ the e'chan$e

rate shoud increase :" and there& raise

a$$re$ate out%ut and em%o&ment in the short

run(

! "e8ationar& demand mana$ement, to

discoura$e e'%enditure on im%orts, a

$overnment ma& ado%t de8ationar& 0sca and

monetar& %oicies(

! 3m%ort restrictions, a countr& ma& see to

reduce e'%enditure on im%orts & im%osin$

im%ort restrictions incudin$ tariIs and 9uotas(


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unit 2 economics proper

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