Actual Growth is an increase in real incomes or GDP.
Potential Growth is an increase in the productive capacity in a country.
GDP must be given /capita. If Y increases by 10%, but population size increases by 20%, people are actually wore off per head.
How is GDP measured?
GDP is the:
- Sum of all goods and services produced in a country in one year.
- Sum of all incomes earned in a year
- Sum of all expenditure in one country in a year.
If GDP increases, it shows that people are spending more, earning more and producing more --> Growth.
Inflation is a sustained rise in the general price level.
How is inflation measured?
Inflation is measured using either the Consumer Price Index (CPI) or the Retail Price Index (RPI).
RPI & CPI
The RPI: The RPI is the traditional measure of inflation in the UK.
The RPI measures the average price of the typical 'basket of goods' bought by the average household. It also includes housing costs.
RPIX excludes mortgage payments from the RPI calculation as they can be very volatile and have a distorting effect on the RPI.
RPIY excludes both mortgage repayments and indirect taxes. Indirect taxes are taxes such as those put on petrol or cigarettes.
The CPI: The CPI is a more recent measure of Inflation.
It can be used to compare inflation on an international scale as it is used around the globe whereas the RPI is unique to the UK.
Two surveys are carried out for the CPI.
One to find out what goods people buy and one is to see what the prices are of these goods (this is done each month).
Demand Pull Inflation
Demand Pull Inflation:
In any market, if there is a significant increase in the demand but no increase in the supply, the Price will increase.
When there is too much demand, the Price Level will rise.
Increases in the AD can be caused by:
- Consumer spending rising excessively. Interest rates could be low and consumers are spending large amounts on their credit cards.
- Firms may have increased their investment spending. Perhaps responding to large increases in demand and so need to increase their supply.
- The government might be increasing its spending or cutting taxes.
- World demand for UK exports may be rising.
Cost Push Inflation
Cost Push Inflation:
This occurs because of rising costs- i.e. factors of production are becoming more expensive.
- Wage increases
- Imports becoming more expensive
- Wanting a better profit margin
- Government increasing corportaion tax or indirect taxes (i.e. the tax on cigarettes).
Firms will try to pass on these costs to the consumer by increasing prices.
Employment and Unemployment
The workforce consists of those pepole who are at work or those of working age who areable and willing to work.
The level of employment is the actual number of people who are in work.
The rate of employment is the proportion of the workforce who are in work.
The unemployed are pepole are are willing and available to work, but are not currently employed.
The level of unemplyoment is the number out of work and the rate of unemployment is this as a proportion of the workforce.
Factors that influence the levels of Employment
- School Leaving Age. Rising to 18 vy 2015. Employment in the age range 16-18 will fall, but in the long term, employment will rise as people finish school with more, and better, qualifications.
- Number of school leavers entering higher or further education. 40% currently go to Univertisy or continue past 18. However set to fall after £9000/year rate introduced.
- Level of net migration. 37% of immigrants come to study. 34% come to work. Fallen since major influx in 2004.
- Availablility of jobs. More jobs = higher employment.
- Levels of Tax and Benefits. If income tax is high or benefits are high then there is no incentive to work.
Labour Force Survey
The LFS is used by the International Labour Survey, it is now the official measure used in the UK.
It involves face-to-face interviews followed by quaterly telephone surveys of 60,000 households. They are asked questions such as- "has anyone in the household been out of work for more than 4 weeks who is ready to start work in the next 2 weeks?"
It applies to anyone over the age of 16- data is inaccurate as it isn't published until 6 weeks after the survey was taken.
The Claimant Count
This is a measure of unemployment that records the number of people who are claiming Job Seekers Allowance (JSA).
There is a stigma attached to JSA and so many who could claim do not do so. Many pepole are not able to claim it as the criteria to qualify for it are very tught. E.g. If you have resigned from a job within the last 6 months or have turned down 3 job offers, you are not eligible.
Types of Unemployment
The 'Classical View' on unemployment is that there is no long-term unemployment. People are not working because they are not willing to accept a low wage. The jobs are there, people just are not willing to take them.
The Keynesian view is that people can be unemloyed in the long run. There is insufficient AD. This is known at demand deficient unemployment.
This can be caused by:
- People saving too much and not spending enough
- Lack of business confidence
- Increase in the value of currency
- Oil price rises
- Increase in the use of cheap imports
Structual Unemployment- When people are retraining. Moving from one sectory to another. The economy is being re-structure. (e.g. move from manufacturing goods to offering services.
Frinctional Unemployment- When people are between jobs.
Costs of Unemployment
The costs of unemployment to the economy include:
- The cost to the individual and dependants. People who are unemployed will have lower incomes (if any) and their living standards will fall. The longer people are out of work, the lower their morale can go and their skill set could quickly become useless.
- The cost to firms. People will be spending less and so they will have to lower their prices to a level that people can afford. They may see an increase in the work rate of their employees as people value their jobs more.
- The cost to government. As unemployment increases, the governemnt's tax revenue decreases and their expenditure on benefits increases.
Balance of Payments
The balance of payments is a record of payments between one country and the rest of the world. Most significant part is the current account which includes:
- trade in goods
- trade in services
- investment income and transfers
A country that exports a lot will have a surplus on the current account. A country that imports more than it exports will have a trade deficit.
Causes of a trade deficit:
- Importing too many goods
- Exports are not appealing (quality/price)
- Strength of the currency
- Stage of the business cycle
- A deficit is only an issue when it is unsustainable.
Aggregate Demand and Aggregate Supply
Aggregate means 'Added together'.
AD is the total planned expenditure on goods and services produced in the UK.
AS is the total planned output of goods and services.
The equilibrium point where they meet determines the average price level and the equilibrium real output level.
Aggregate Demand=consumption + Investment + government spending + exports - imports
AD = C + I + G + X - M
The AD curve is downward sloping. This is NOT because people buy more thing when they are cheaper. There are three ways to explain a downward sloping AD curve:
- Lower prices in an economy = increased international competitiveness.
More exports and fewer imports.
- The total amount of spending will be equal whether prices are low or high as people have approximately the same amount of money to spend- the area under the curve will be fairly constant.
- At higher price levels, interest rates are likely to be raised by bank of england. Investment falls, savings increase.
- Consumption is the spending by households on goods and services.
- It is the main component of AD (about 65%)
- It measures the amount that people want to spend at certain price levels.
- If consumers are feeling confident, they are more likely to make larger purchaces.
- Higher interest rates leave consumers with less spending money and increase the cost of a purchase.
- There is an inverse relationship between interest rates and investment- There is an opportunity cost when financing increases in the capital stock for example.
- Firms often borrow from banks to fund investment, if interest rates rise, the cost of investment rises.
- Some argue that interest rates don't have such a big impact- investors are driven by other things such as confidence in the market in the future etc etc
- A change in investment will result in a change in AD, but a change in AD will also result in a change in investment.
- Government spending in the UK = 40% of all spending within the economy (£560bn).
- The difference between tax revenue and spending is the budget deficit or surplus.
- The government can manipulate AD by changing how much it is spending.
- The national debt is the accumulation of budget deficits over many years. Interest must be payed on this debt and so there can be costs for future generation.
- The keynsian view is that fiscal policy is a good tool that should be used to manipulate AD.
- The classical view is that fiscal policy results only in inflation, not growth.
- Exports represent an injection into the circular flow of income.
- In the short run, the PED for exports and imports tends to be low- contracts signed for deals, traded components may be a very small % of a firms costs.
- The state of the global market is important. If there is a recession in the USA, but not in the UK, fewer UK goods will be exported to the USA. If there is inflation in the UK but not in other countries, UK goods become uncompetitive.
AS is the amount that firms are willing to produce at various price levels.
It is influenced by productivity which is influced by the factors of production, levels of investment, availability of labour and supply-side policies.
The classical view of AS:
- In the long run an economy will operate at full capacity- there will be no unemployed resources in the economy.
- The AS curve is verticle.
- If there are any unemployed resources, the prices of these factors will fall until the surplus dissapears.
The Keynsian view of AS:
- The equilibrium level of output can occur below the full employment level of output.
- The AS curve is backward bending- 3 sections: Spacre capacity, bottlenecks and full employment.
AD & AS Diagrams
AD & AS Diagrams
Shifts in the AS Curve
The Labour Market:
- Productivity gap closes- Productivity is output per unit of input. If it increases relative to a country's main trading paterns then the productivity gap is said to be closing.
- Education and skills improve- Increased spending on education and training should mean that a country's workforce can produce more output per worker.
- Health spending increases: An increase in resources in the health sectors will mean that workers have fewer sick days and are active for longer. However, this benefit may not be so great as wages must be paid to new staff in the health sector.
The Product Market:
- Sources of raw materials change. In a developed country, most raw materials are imported. If global competition increases, UK costs will fall.
- Exchange rates fall: If the Euro fell in value against the pound, many costs would fall in the UK, AS shifts out.
- International trade increases: As a country opens up to more trade, competition drives down prices.
- Tech advances: Innovation and investment in new ideas tend to reduce costs for all firms.
- Regulation changes: Cutting red tape will shift AS outwards.
Positive Output Gap- If the economy is growing faster than the trend, pressures will grow in the economy (e.g. wage pressures and shortages of raw goods). Increasing interest rates to curb inflation.
Negative Output Gap- If the economy is growing below the trend, there is likely to be spare capacity in the ecnomy. There is scope for a cut in interest rates which is less likely to cause inflationary pressures.
Causes of Economic Growth:
- Can be becuase there is an increase in one of the components of AD.
AD = C + I + G + (X-M)
- Can also be due to an increase in AS. Costs of production fall or a government supply-side policy,
If AD increases but is over the verticle part of the AS curve, there will not be economic growth, only inflation.