Revision notes on unit 2 economics

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MACRO Unit 2 The UK Economy
The performance of the economy can have a major impact upon peoples lives. It
will influence the type of jobs people have and the goods and services available to
them, and whether they can afford to buy them.
The government has 4 macro-economic objectives:
1) low unemployment
2) low and stable inflation
3) sustainable Economic growth
4) balance of payments equilibrium
A number of key indicators can be used to illustrate the success of an economy:
1) the level of output, and Economic growth
2) the inflation rate
3) level and rate of unemployment
4) the Balance of Payments
If the economy is growing it can normally be judged as successful.
In addition the government will also consider:
a more equal the distribution of income
protection of the environment & sustainability of growth
The Circular Flow of Income and Injections & Leakages
In the simple, closed economy, it is assumed that households own all factors of
production, which they then sell to firms for financial rewards. It is these rewards
which enable households to carry out their day to day purchases.
Unit 2 The UK Econom y 6EC02 1 St Pau l's School 2011

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However the simple circular flow, as depicted in Figure 7, is too simplistic to be of
any real use. In the open economy there are 3 injections into the circular flow.
Investment by firms (I)
Government spending (G)
Exports (X)
Each represents an autonomous addition to the circular flow income.…read more

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The government measures all three money flows, goods & services,
expenditure and income and they should be identity be equal.
The preferred measure is the expenditure method which takes spending by
consumer (C), government spending (G), spending by firms (I) and the net trade the
UK enters into (X-M).
The Expenditure Method: C + I + G + (X - M)
For this method to be accurate the value of subsidies must be added and taxes on
goods deducted.…read more

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HDI is an index which measures national socio-economic development developed by
the United Nations. Up until 2009, it was based on measures of life expectancy,
educational attainment and was adjusted for real per capita income.
The HDI combined three basic dimensions:
Life expectancy at birth, as an index of population health and longevity
Knowledge and education, as measured by the adult literacy rate
(with two-thirds weighting) and the combined primary, secondary,
and tertiary gross enrollment ratio (with one-third weighting).…read more

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If a countrys output is rising, this suggests that a countrys citizens are experiencing
higher living standards. The most common indicator of economic growth is a rise in
real GDP.
Actual and Potential Growth
An increase in the productive capacity of an economy increases the potential
growth, whilst an increase in output results in an actual increase in output. A shift in
the PPF illustrates an increase in productive potential.…read more

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Growth below the trend growth rate, where AD and so actual growth is
below LRAS and the economys potential growth rate. This leads to a negative
output gap and so unemployment and downward pressure on prices.
GDP Measurement Problems
1. Black Economy: This exists because when the output of some goods and
services is deliberately not declared. This can be for 2 reasons, to avoid tax, for
example ,,cash in hand deals with plumbers etc.…read more

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Increased Tax Revenue: Greater economic growth could result in higher
tax revenue allowing the government to increase spending on health,
education or whatever else is seen to be a priority.
Higher Employment: Economic growth can result in greater demand and
therefore greater employment.
Increased investment as confidence improves, or due to the accelerator,
or higher profits for firms. This means the economy will have more capital
per worker and so higher productivity and more future growth.…read more

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Inflation can be defined as a sustained rise in the agreed general price level.
A low and steady inflation rate allows business to maintain confidence in the
economy. A high level of inflation, in excess of a countrys main trading partners can
create problems in competitiveness resulting in a decline in trade.
The main measure of inflation in the UK is calculated through the use of the Retail
Price Index (RPI).…read more

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Other measures of inflation
RPI X: This measure is the RPI minus mortgage interest payments. There are 2
arguments for excluding mortgage interest.
1. For comparison purposes a number of other countries do not include it
2. Mortgage interest payments are influenced by changes in interest rates, so a
rise in interest rates designed to reduce inflation may have opposite effect of
raising it.
The Bank of England target is 2.0% ± 1% (was 2.…read more

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Causes of Inflation
There are two main causes of inflation:
Demand-pull inflation -
This occurs when AD increases (due
to greater consumption, investment,
government spending or net exports),
pushing against the limits imposed by
the AS curve at full employment. In
the diagram (left), as AD shifts from
AD to AD1, the price level rises to P2.…read more


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