Economics Revision

  • Created by: Michaela
  • Created on: 18-05-13 12:59


  • Macroeconomics:the study of the economy as a whole
  • Microeconomics:the study of individual parts of the economy.
  • Macroeconomics Objectives: the aims of a governemnt relating to key economic performance indicators such as economic growth,inflation and unemployment.

Macroeconomic Objectives:

  • Inflation: general and persistent price rise
  • Unemployment:thoses who want a job but cannot find work
  • Protect the environment:
  • Balance of payments (current account):
  • Economic growth: gross domestic output
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Economic Growth

  • Economic Growth:the increase in national income overtime
  • National Income:the value of income,output or expenditure over time
  • Gross Domestic Product: an internationally recognised measure of national income

Limitations of GDP as a measure of growth

  • Inflation:price increase can distort growth rates -inflation = growth- adjusted using real GDP which takes into account the inflation
  • Population changes:population growth must be taken into account when analysing growth patterns - GDP per capita can be calculated(GDP divided by the population)
  • Statistical errors.
  • The value of home produced goods:some goods and services are traded but not recorded-value of National income is understated
  • GDP and living standards:used to measure living standards- GDP increases does not automatically mean living standards increase.
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The Economic Cycle

Classic shape of the business cycle (

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Economic Cycle

  • Boom:th epeak of the conomic cycle where GDP is growing fastest
  • Downturn: aperiod where GDP grows but more slowly
  • Depression or slump: the bottom of the economic cycle where GDP starts to fall with significant increases in unemloyment
  • Recession:less sevre form fo depression

Bebefits of Economic Growth

  • Increased incomes
  • More leisure time
  • Greater life extpectancy
  • Better public services

Problems with economic growth

  • Regional Differneces
  • Envirnmental Differnces
  • Unsustainable growth
  • Inflation
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  • Inflation:a general and persistant increase in prices over time
  • Aggregate Demad: total demand in an economy
  • Consumer Price index:a meausre of the general price level(excluding housing costs)
  • Cost push inflation: infaltion caused by rising bussiness costs
  • Deflation: a period where the level of aggregate demad is falling
  • Demand pull inflation: inflation caused by too much demand in the economy relative to supply
  • Monetarists:economists that beive there is a strong link between growth in money supply and inflation
  • Money supply inflation:inflation caused by rapid money supply
  • Retail Price index:meausre of the general price increase includes house prices and council tax
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What Causes Inflation

Demand-pull inflation:

  • rising consumer sprending due to low  intrest rates or tax cuts
  • sharp increases in Governement spending
  • rising demand for resources by firms
  • booming demand for exports

Cost Push Inflation

  • due to rising costs.
  • rising costs of imports
  • wage increase
  • increase in taxation

Money Supply Inflation

  • borrow more money to fund extra spending-this adds to the money supply because now there are more bank depsosits.
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Consequences of Inflation

  • Reduced purchasing power-get less for same amount of money or even more money-unable to buy as much with income
  • Reduces the value of savings.
  • Increased business costs-price increases mean businesses will have to pay more for resources/workers want higher wages-may result in conflict/increase their price frequently-menu costs/shoe leather costs-more time looking for lowest prices.
  • Balance of  payment problems-may find it difficult to sell to overseas markets as price of exports increases-as a result demand for exports will fall meaning the current account(international trade in goods and services) will be affected. If exports fall there wil be surplus on the account will be reduced and a deficit will increase.
  • Increase government spending-they have to as a lot of it is linked with rate of inflation eg. state pensions and benefits are index related.

Inflation's and the function of money:

  • Medium of exchange:exchanged for goods and services
  • store  of value: money can be stored and used at a later date
  • Unit of account: money used to measure the value of goods and services
  • Standard for deferred payments:money can be used to settle debt
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  • Index linking:where certain governemnt payments are linked to RPI
  • Purchasing power:the amount of goods and services that can be bought with a mixed sum of money
  • Hyperinflation:price increases are out of control

High inflation generally has a negative impact on money. It may result in hyperinflation and money may no longer exist as a medium for exchange.May not be a good store of value if inflation us higher than interest rates.People will start to become uncertain about the true values of goods and services.

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  • Measured: carry out a survey
  • economically inactive - do not meet the criteria for unemployment
  • Unemployed:those who are actively seeking work in the last 4 weeks and are able to start work in the next 2 weeks.

Types of Unemployment:

  • Cyclical or demand deficit unemployment-unemployment caused by falling demand as a result of a downturn in the economic cycle
  • Structural Unemployment:unemployment caused by changes in the structure of the economy
  • Sectoral unemployment: industry decline
  • Technological unemployment: improved technology
  • regional unemployment:eg. ship building in the north -east has suffered
  • Frictional Unemployment:as workers are unemployed for a short period of time as they move from one job to another
  • Seasonal Unemployment:seasonal workers such as holiday resort staff
  • Voluntary Unemployment:people choosing not to work
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The effects of unemployment

  • Costs to the individual-lose benefits/homes/decreased standard of living
  • Costs to business-redundancy money/remaining workers are demotivated/spare capacity-inefficient/fall in demand due to less income due to unemployment
  • Cost to the economy-no contribution to production/waste of resource and lowers national income/tax revenue will fall-less money spent on public sector eg. hospitals.
  • Costs to local community-spirit decreases/increased crime-vandalism/run down areas/environment starts to look run down.
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Balance of payments

  • Balance of trade ot visible trade: the difference between the visible exports and the invisible imports.
  • Balance of payments: a record all transactions relating to international trade.
  • Current account: part of the balance of payments where all exports and imports are recorded
  • Imports:goods and services bought overseas.
  • Invisible trade: trade in services
  • visible trade: trade in physical goods

Effects of Current Account deficit:more imports than exports

  • increase in external debt
  • rise in unemployment
  • downward pressure on the exchange rate-price of imports increases leading to inflation.
  • may reflect structural weakness-domestic firms struggle due to lack of competitivness.
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Balance of payments

Effects of current account surplus: more exports than imports.

  • raising exports will generate employment and economic growth
  • build up foreign  currency reserves or lend money overseas.
  • domestic shortages
  • rising exchange rate will increase the price of imports resulting in decreased demand.
  • if one country has very surplus it means others have deficits-lead to international instability.

The balance of payments and the Government

  • exports should be roughly equal to imports
  • should monitor it and if it becomes unmanageable they should take measure to reduce it.
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Protection of the enviornment

Methods of protection:

  • Government regulation
  • Environemnt Agencies
  • Taxation:land fill tax-may be argued that high environmental taxes are set in order to raise revenue for the government.
  • Subsidies
  • Compensation
  • Recycling
  • International Targets
  • Permits: certain amount of "allowance" of pollution 
  • Road pricing and charges eg. london congestion charge
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Economic Policies

  • Economic Policies:the range of actions taken by the government to help achieve its macroeconomic objectives
  • Policy instruments:the economic variables such as the rate of interest ,taxation and levels government expenditure that can be adjusted by the government



Supply side policies

Other economic policies

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Fiscal Policy

  • Fiscal Policy:decisions about government spending , taxation and levels of borrowing which affect aggregate demand in the economy.
  • Budget: the governments spending and revenue plans for the next year
  • Buget Deficit:the amount by which government spending exceeds government revenue
  • Contractionary fiscal policy:fiscal measures designed to dampen demand in the economy
  • Budget surplus: the amount at which government revenue exceeds government spending
  • Direct taxes:taxes levied on the income earned by firms and individuals
  • Expansionary Fiscal Policy: designed to stimulate demand in the economy

Government Expenditure:

  • mandatory spending and discretionary spending
  • Spent on various thing such as health care, education and protection such as the army.
  • Can be used to stimulate the economy if spending is used wisely
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Fiscal Policy


  • to pay for public sector services
  • to discourage certain activities.
  • to control aggregate demand.
  • distribution of wealth made fairer.

Direct Taxes:

  • Income tax
  • National Insurance contribution-used for NHS and pensions
  • corporation tax
  • capital gains tax
  • inheritance tax

INdirect tax:

  • VAT                                 Council tax-local services         Stamp Duties-houses and shares
  • Duties                              Customs Duties-imports
  • Vehicle excise duty          Business Rates
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Fiscal Policy

Environmental Txaes:

  • Landfill tax
  • Climate change Levy- meet its commitment to reduce greenhouse gases
  • Aggregate levy-tax on sand , gravel and rock dug from the ground-reduce environmental problems caused by quarrying.

Demand Management:

  • Inflation: Contractionary policy used-used to dampen quickly growing demand-taxes increased and gov. spending decreases-reduces disposable income relieving  inflationary pressure.
  • Economic Growth:Expansionary policy-increases in gov. expenditure Will increase aggregate demand.More jobs are made available leads to more demand for goods and services.Cuts in taxes also generate demand as people will have more money to spend.Also increased investment in schools and transport links -capital projects.
  • Unemployment- Expansionary policy-increase gov.spending and decreased taxation increase demand and businesses will have to employ more people to keep up with the demand.Government could help by starting construction on new hospitals and gov.building
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Fiscal Policy

  • Current Account Deficit:eg. large deficit on the current account contractionary policy is used to reduce aggregate demand-reduce demand for imports.
  • Fiscal Policy and the environment: taxes and subsidies used to decrease impact on environment.

Trade offs:

  • can lead to the creation of other problems
  • contractionsary policy to reduce inflation is likely to lead to unemployment.

Positive Effects:

  • Unemployment will fall
  • with more spending and investment- GDP will grow.
  • tax revenues may be higher -more resources
  • jobs will be created- in the public sector.
  • Economy will grow because government expenditure leads to increase in demand.
  • improvement in government services such as schooling and health care.
  • infrastructure will improve if money is spent on public projects
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Negative Effects of expansionary fiscal policy

  • threat of inflation-rise in demand
  • tax cuts may lead to increase in demand for imports increasing current account deficit.
  • Increase in government debt-drains governments resources as taxes are lowers and gov. spending is higher.-gov. have to borrow more money and pay more interest.

Postive Effects of Contractionary Fiscal Policy

  • f inflation is rising it will help to dampen demand.relieves inflationary pressure and allows economy to grow at sustainable rate.
  • Government Finances will improve-more tax revenue/gov.spending less.
  • imports will fall due to less disposable income improve the current account.

Negative Effects

  • result in unemployment-higher taxes business lay off workers/reduces gov.spending
  • GDP starts to slow
  • Decreased living standards-repairs to infrastructure reduces/Increased prices of public Services
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Monetary Policy

  • Monetary Policy:the use of interest rates and money supply to control aggregate demand in the eeconomy
  • monetarysupply:the amount of money circulating in the eeconomy
  • Baserate:the rate of interest set by the MPC(monetary policy committee from the bank of england) which influences all other rates in the economy
  • Rate of interest:the price of money.

Intrest Rates:

  • spending in households and firms is affected by borrowed money.
  • The MPC set an interest rate that prevents inflation from exceeding the target.

Money Supply

  • money supply includes all notes,.coins and money held in bank accounts in the eeconomy.
  • Quantitative Easing :used to control the supply of money.involves having the central banks buying financial assets such as bonds form commercial banks this results in a flow of cash into the commercial banks.Can cause inflation as the money is electronic and does not exist as it increases the balance of cash without ever giving money
  • Hard to control the supply of money as it is hard to define
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Monetary Policy

Rte of interest and its effects:

  • Consumption:interest rates fall loans from households will rise to buy big ticket purchase.mortgages payments fall-have more money to spend increases ddemand in economy.Reward to savers is lower this may encourage people to spend more.
  • Investment:firms welcome lower rates-miuch of the money used to finace investment is borrowed-costs are lowers and profits are higher.for investment.
  • Exports and imports: Interest rate fall , exchange rate is likely to fall as well-price of exports becomes cheaper and demand will rise for them and firms will benefit as they will sell more good and services. Price of imports may rise-decreasing ddemand-decrease in imports and an increase in exports will increase aggregate ddemand.

Macroeconomic Objectives:

  • Inflation:caused by money supply growing too quickly-slow speed at which money supply is growing -tight monetary policy.
  • Unemployment:loose monetary policy-interest rates are cut and and loans increase , increasing spending and effecting firms.
  • Economic Growth:loose monetary policy may be usd to get out of a recession
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Monetary Policy

Current Account: tight monetary policy could be used to decrease imports, if  interest rates were increased demand for exports will be dearer and imports will be cheaper.Depend s on the following:

  • income elasticity of imports-imports income elastic high interest rates will reduce the demand
  • The strength of the link between interest rate and exchange rates: strong link-high interest rate will rise exchange rate and exports will become expensive and imports will become cheaper.
  • The price elasticity of demand for imports and exports: if they are both price elastic and the exchange rate does not rise when interest rates does imports will be cheaper and exports dearer.

Trade offs:

  • rising interest rates to reduce inflation will eventually decrease aggregate demand  but this may lead to unemployment.
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Monetary Policy and its effects

Tight Monetary PLociy:reduce inflation

Positive effects

  • discourage borrowing from firms and households reducing aggregate demand and relieving inflationary pressure.
  • Higher interst rates mean the reawrd to savers will increase.
  • May strengthen the exchange rate making imports cheaper.

Negative Effects:

  • higher interests rates will discourage consumers and businesses from borrowing there will be a fall in consumption and investment-reduce aggregate demand and lower economic growth+unemployment is likely to rise.
  • higher motagage payment-decrease spending power-reducing aggregate demand.Firms will react by laying off more workers.
  • hamper firms from long term development of firms as they cannot develop new technology or invest.may also loose competitive edge in foreign market.
  • higher exchnage rates will then lead to expensive exports and forms will eract by laying off workers.
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Monetary Policy and its effects

Loose monetary Policy:lower intrest rates

Positive Effects:

  • encourage borrowing-increase aggregate demand, stimulate jobs  and economic growth
  • exchnage rate to fall-demand for exports will increase because the y will be cheaper , improving the current account
  • amount of debt paid for gov. debt will be lower-more money available for government.
  • encourage firms to invest which may improve efficiency.

Negative effects:

  • if monetary stimulus is too string it could lead to firms not being able to cope with the increase in aggregate demand-may not be able to increase supply leading to increase in price an inflation
  • higher aggregate demand may **** in imports and the current account may worsen
  • force the exchange rate down which means imports become more expensive -may cause inflation.
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Supply Side policy

  • Supply side policies: government measures designed to increase aggreaget supply int he economy.
  • Improve flexibility in the labour market and restore the incentive to work by removing restrictions and lowering taxes on work and enterprise.
  • Promote competition through privatisation,dergulation and helping small firms.
  • Increase investment by improving the flow of capital into capital markets.

Labour markets:imporve effeciency using supply side polices

  • improving flexibility.
  • Closed shops made illegal
  • Secret ballots enforced before a strike
  • Secondary picketing made illegal
  • Wage councils abolished-wages could not be fixed

Restoring  incentives: some argue that high taxes on income and profit will reduce output in the economy as it discourages people from setting up or developing businesses:

  • Workers are likely to retire early and refuse overtime.
  • entrepreneur's less like to take risks
  • those with workign spouses may choose not to work
  • highly productive people my move to other countries
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Supply Side policy

Increasing the quality and quantity of labour:

  • if people receive more education and training the quality of the workforce will improve-this will help labour productivity and increase aggregate supply.
  • changing the role of female sin society.
  • more retired people choose to work

Product markets: policies aimed to improve efficiency of production through the use of promoting competition and reduced red tape businesses these have been used:Privatisation

  • Deregulation:reducing red tape and relaxing regulations that restrictcompetition
  • Helping small firms: if more firms set up aggregate supply will increase-taxes on small businesses reduced/reduction in red tape/number of tax allowances introduced for those eho invest in small businesses.
  • free advisory services

Capital Markets:Investment int public sector through the gov.-schools /improved transport and communication systems

  • taxing less profit allows for more investment
  • firms can claim capital allowance when buying machines and equipment
  • tax incentives used to encourage people to save more and buy shares in companies which encourage direct investment into the company.
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Balance of Payments

·       Balance of payments :(BOP) is the method countries use to monitor all international monetary transactions at a specific period of time.

   The Current Account:The current account is used to mark the inflow and outflow of goods and services into a country. Earnings on investments, both public and private, are also put into the current account. 

Exports: Goods and services sold overseas

Definition of Current Account Deficit: Occurs when a country's total imports of goods, services and transfers is greater than the country's total export of goods, services and transfers

 Impacts of Current Account Deficit: Increase in external debt. This means the nation will owe money to other nations

·       A rise in unemployment. This is because people may be buying imports in preference to domestically produced goods.

·       Downward pressure on exchange rate .The price of imports will rise and contribute to inflation in the economy.

·       It may also reflect structural weakness. This means that domestic firms may struggle because they are not competitive.

*A substantial current account deficit is not necessarily a bad thing for certain countries. Developing counties may run a current account deficit in the short term to increase local productivity and exports in the future.


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Balance of payments

 Definition of Current Account Surplus: An imbalance in a nation's balance of payments current account in which payments received by the country for selling domestic exports are greater than payments made by the country for purchasing imports. 

 Impacts of Current Account Surplus:

·       Rising exports will generate economic growth and greater employment

·       A nation can build up foreign currency reserves or lend money abroad

·       Domestic shortages if to many goods sold aboard 

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Exchange rates

  • Exchange rate:An exchange rate is the price of one currency in terms of another.
  • Exchange rates are determined by the supply and demand for a currency, therefore it is determined by market forces at the foreign exchange market.This is where currencies are brought and sold.why would someone want to buy a currency? when a company buys goods from offshore they have to pay for the goods in the exported countries local currency. Therefore they have to buy that currency on the foreign exchange market.

Factors affecting the demand for a currency:

  • Demand for export
  • .Inward Foreign direct Investment
  • Interest Rates

Fcators affecting the supply fo a currency:

  • Demand for imports
  • Outward Foreign Direct Investment
  • Intrest Rates in others countries
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Exchange rates

impact of rising and fallung excahnge rates:

  • W-WEAK







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