The Global Economy

Revision cards for the january 2012 exam

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  • Created by: brunetty
  • Created on: 30-01-12 13:38

Recent macroeconomic performance in the UK

Macroeconomic performance refers to an assessment of how well a country is doing in reaching key objectives of government policy. The main aim of policy is usually an improvement in the real standard of living for their population. The term ‘real’ means that we have taken into account the effects of rising prices so that we get a better picture of how many goods and services we can afford to buy and consume. 

The UK is one of the world largest economie, after the USA,Japan, and Germeny. The UK faced a deep recession in the early 1990's,the economy bounced back and enjoyed a avaerage growth of 2.9% between 1993 and 2008. 

One would aregue that the UK current account deficit will drag down future growth for the economie. If the deficit has been financed through borrowing to pay current spending, the money will one day have to be repaid with interest.  

The only worrying future of the performance of the UK is their persistent current account deficit.

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Short-run and Long-run economic growth

In the short run, economic growth comes from the economy making more intensive use of its existing factors of production. Growth comes from a higher level of aggregate demand leading to an expansion of aggregate supply. This supply comes from utilising existing labour and capital inputs more intensely. We have seen since 1993 a large fall in the rate of unemployment and a decline in the amount of spare capacity in the economy.

In the long run, economic growth comes from increasing the stock of available inputs (land, labour and capital) together with improvements in factor productivity and also technological change. These factors cause an increase in long-run aggregate supply and allow the economy to operate at a higher level of potential output.

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The different stages of economic cycle

 Economic Boom :

A boom occurs when national output is rising strongly at a rate faster than the trend rate of growth (or long-term growth rate) of about 2.5% per year. In boom conditions, output and employment are both expanding and the level of aggregate demand for goods and services is very high. Typically, businesses use the opportunity of a boom to raise output and also widen their profit margins. 

Economic Slowdown:

A slowdown occurs when the rate of growth decelerates - but national output is still rising. If the economy continues to grow (albeit at a slower rate) without falling into outright recession, this is known as a soft-landing. 

 Economic Recession:

A recession means a fall in the level of real national output (i.e. a period when the rate of economic growth is negative). National output declines, leading to a contraction in employment, incomes and profits. The last recession in Britain lasted from the summer of 1990 through to the autumn of 1992. When real GDP reaches a low point at the end of the recession, the economy has reached the trough - economic recovery is imminent.  

Economic Recovery:

A recovery occurs when real national output picks up from the trough reached at the low point of the recession. The pace of recovery depends in part on how quickly aggregate demand starts to rise after the economic downturn. And, the extent to which producers raise output and rebuild their stock levels in anticipation of a rise in demand.

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The nature and significance of output gap

The output gap is used in assessing the degree of demand-pull inflationary pressure in the economy at a particular time. In recent years, macro-economic policy has placed increasing emphasis on output gap even though cannot be observed directly!

Measuring the output gap is difficult. Economists need to measure the true level of aggregate demand (AD = C+I+G+X-M) and also aggregate supply – a measure of the productive potential of the economy in a given time period.

Aggregate supply (AS) is determined by a number of factors. These include the utilisation rates of existing labour and capital inputs, the change to the capital stock and the effective labour supply and also the rate of growth of factor productivity. If AS expands each year, the economy can increase the real volume of output to meet an expansion of aggregate demand.

When aggregate demand is well below the productive potential of the economy (so called potential GDP) then a negative output gap exists. In simple terms, current output and spending is well below what the economy could normally sustain. In this situation there is spare capacity in the economy. 

The implication is that the rate of inflation is likely to fall because inflationary pressure are falling. 

It is important to note that a negative output gap does not tell us what the rate of inflation is going to be – merely it suggests the direction in which inflation is likely to move.

When actual GDP lies well above potential GDP, there is a positive output gap, meaning that inflation pressures will be rising. This often happens at the end of a period of sustained economic growth above the long-term average growth of national output.

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Causes of economic growth in the short and long ru

Long run (LRAS) or potential growth can increase for the following reasons:

  1. Increased capital. E.g. investment in new factories or investment in infrastructure, such as roads and telephones.
  2. Increase in working population, e.g. through immigration, higher birth rate.
  3. Increase in Labour productivity, through better education and training or improved technology.
  4. Discovering new raw materials.
  5. Technological improvements to improve the productivity of capital and labour e.g. Microcomputers and the internet have both contributed to increased economic growth.
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The national income multiplier and its determinant

The National Income Multiplier says that an initial increase in spending can cause further rounds of spending. Therefore, the final increase in National Income is greater than the initial spending (or injection of Money)

 e.g if Government increase spending on the wages of nurses by £2billion. That means National Income increases by £2billion. However, if nurses spend part of their extra wages, additional output and incomes will be generated. The final increase in National Income may be £3 billion. Therefore, there is a multiplier effect of 3/2 = 1.5

 What Determines size of Multiplier?

The size of the multiplier depends on withdrawals and the marginal propensity to consume

If nurses spend 90% of their extra income, the multiplier effect will be high. If they spend only 10% of extra income the multiplier effect will be low.

A cut in income tax means that people keep a high % of their gross income. Therefore the multiplier effect will be higher. A cut in income tax is a withdrawal – leading to less spending and therefore it reduces the size of the multiplier.

Multiplier Formula = 1 / 1-mpc

As income tax increases the marginal propensity to consume will fall. 

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