UK Economic Activity

Government Objectives

Rate of inflation: 2.0% CPI

Economic growth: 2.5% per annum

Unemployment: 3%

Cut child poverty and reduce pensioner poverty

Balance of trade: reduce deficit

Environment: reduce carbon emissions by 20% by 2020


Conflicting objectives: increasing unemployment decreases inflation

  aaaaaaaaaaaaaaaa  high economic growth can increase inflation by more than is wanted

aaaaaaaaaaaaaaaaa  high economic growth worsens trade deficit

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National Income

National income measures monetary value of flow of output of goods and services produced in an economy over a period of time.

GDP is the total value of output produced in a given period of time. To see if growth has occurred it is measured over a year. Includes output of foreign owned businesses as a result of FDI.

GDP (expenditure)- aggregate demand + exports - imports

GDP (factor incomes)- income from factor of productions

GDP (value of output)- value from main economic sectors i.e. primary + secondary + manufacturing + quarternary

Gross National Income= GDP + money from overseas investments - what foreigners in UK sent home

UK GDP: banking and finance, tourism, retailing, education and health

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Circular Flow of Income

The circular flow of income shows connections between different sectors. It also shows how national income of GDP is calculated.

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Circular Flow of Income not in Equilibrium


demand for factors of production increases as more are needed to increase production.

factors of production must be paid for so incomes are received.

households have more money so they are more willing to spend.

demand increases so firms are more willing to produce.

output increases as firms produce more.

national income rises as more money is flowing around the economy.


Leakages>Injections: opposite happens resulting in national income decreasing.

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Benefits of National Income

Signals that there could be a rise in GDP growth.

More factors of production demand leading to full employment efficiency.

Generates more incomes.

More incomes means more spending, so firms receive increased sales revenue.

Firms employ more workers, reducing unemployment (government aim).

Leads to rising standards of living.

More income tax revenue, more government spending, benefits poorest in society.

Country could attract more FDI.

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The Multiplier Effect

The multiplier describes the situation in which an increase (or decrease) in an injection leads to a more than proportionate increase (or decrease) in GDP. It is the ratio of income resulting from a change in an injection.

Average level of saving in UK is 1.5% of income (£300).




MPC- marginal propensity to consume- how willing a consumer is to spend their money when they earn £1 more.

MPS- marginal propensity to save.

Negative multiplier is also possible i.e. during recessions or closure of major businesses.

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Saving and Consuming

When a consumer earns any extra income, they have a choice on how they wish to use it.

The choice is between saving and spending.

In the UK, a greater proportion of income is spent than saved.

Roughly, 90% is spent and 10% is saved.

Therefore, MPC is 0.9 and MPS is 0.1

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Fiscal Policy

Fiscal policy is the use of government taxation and spending to alter levels of aggregate demand in the economy.

Changing income tax can improve incentives for people to look for work, which leads to more being produced. Lowering income tax can also result in an increase in productivity which leads to more output.

Spending on infrastructure provides the capacity needed for businesses to flourish, meaning they can increase their output. Also, it could have a multiplier effect if it leads to an increase in demand for resources.

Spending can also be used to fund an expansion in new small business start-ups creating greater output in the economy.

Spending and tax reductions can encourage research into new products and processes which can lead to more efficient output. Tax incentives can stimulate investment in low carbon technologies which means new products can be created.

Spending on education and investment in health and transport can also have supply-side effects.

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Monetary Policy


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Supply-Side Policy

Supply-side policies aim to increase productivity in the economy which should lead to an increase in total output whilst lowering the average price and attracting more people to the workforce.

Privatisation: selling of state-owned assets to the private sector, who are more efficient as they have a profit motive to reduce costs and develop better services.

Deregulation: reducing barriers to entry to make markets more competitive, which leads to lower prices and better quality goods/services whilst allowing more firms to contribute to output.

Reduce tax: lower income and corporation tax increases incentives for people to work harder, leading to more output.

Increased education and training: results in a more highly skilled workforce which can improve labour productivity, decrease immobility and increase aggregate supply.

Reduce state welfare bonus: encourages unemployed to take jobs.

Improved infrastructure: reduces congestion, workers can arrive on time. COPs decrease for firms.

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Benefits of Economic Growth

Improvements in living standards- GDP per capita increases.

More jobs- full employment of resources leading to more taxation revenue.

Accelerator effect of growth on capital investment- rising demand encourages investment.

Greater business confidence- growth has positive impact on profits.

Better infrastructure.

Potential environmental benefits- more resources to invest in cleaner technologies.

Fiscal dividend- growing economy boosts tax revenue without taxes rising.

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Drawbacks of Economic Growth

Inflation risk- if demand is way ahead of supply prices may rise (structural inflation).

Increased inequality- growth can lead to rising asset prices, but usually only the rich own these assets.

Environmental concern- fast growth can cause negative externalities e.g. noise pollution, lower air quality and road congestion.

Increased consumption of demerit goods- damages social welfare and increased diseases of the rich (obesity and heart disease).

Increase in household and industrial waste.

More sickness due to pollution.

Growth that leads to environmental damage may lower sustainable rate of growth e.g. deforestation.

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Importance of National Income Statistics

National income estimate reveals overall production of economy.

By comparing national income over time, we can know whether the economy is growing, stagnant or declining.

Show contribution made by various sectors, such as manufacturing, agriculture, trade.

By comparing national incomes of various countries, the standards of living of different countries can be compared.

Valuable guide to economic policy- helps decide if industries should be taxed, subsidised etc.


However, there are difficulties in comparing national income over time or between countries: measuring methods may change over time or between countries; self-sufficiency is unrecorded; standards of living is measured by income per person, so population change has to be measured; statistics have to be adjusted for inflation and exchange rate changes (depends on accurate numbers for these); doesn't show range or quality of goods; doesn't show difference in work time.

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$Direct- tax paid directly to Inland Revenue, straight from individual to government. Levied on individual or organisation and can't be passed on to another person. Taxes on income e.g. income tax, corporation tax, inheritance tax, National Insurance contributions.

Indirect- tax is first collected by seller then passed on to Customs and Excise, goes through a third party. Levied on goods or services. Taxes on expenditure e.g. VAT, duties.

Progressive- percentage of income taken rises as income rises e.g. income tax, people who earn more pay more.

Regressive- percentage of income taken falls as income rises e.g. VAT and duties, everyone pays the same amount so it is a smaller proportion of a wealthier person's income.

Three biggest in UK: income tax (£175bn), VAT (£143bn), National Insurance (£130bn)

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Taxation cont.

Purpose: pays for government spending; corrects market failure- decrease consumption alcohol; manage the economy- changing tax rates influences inflation, unemployment, aggregate demand and balance of payments; redistribute income.


Canons of Taxation:

Cost of collection should be low relative to yield of tax- shouldn't be spending lots to collect the tax.

Timing of collection and amount paid should be clear to tax payers.

Means of payment and timing of collection should be convenient to tax payers.

Ability to pay should be taken into consideration.

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Switching to Indirect Taxation

For: change pattern of demand- change relative prices to affect spending e.g. make petrol more expensive then people might use different modes of transport; used to correct market failure- makes polluter pay so private cost equals social cost; don't have a negative impact on work incentives like direct taxes do- people can choose to not buy things they don't need to save money; less easy to avoid- people aren't aware of how much they're paying.

Against: regressive- distribution of income is more unequal; higher indirect taxes cause cost-push inflation if suppliers pass tax on to consumers; if it is high, people might 'boot-leg' e.g. buy alcohol in France where it is cheaper; revenue can be low if inflation is low or during a recession; people may not know how much they are paying- goes against one of the Canons of Taxation.

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Income and Substitute Effect with Taxes

Substitution effect: following an increase in direct taxes, substitutes to work (namely leisure) seem more attractive and people may work less (often called the Laffer Effect).


Income effect: an increase in taxes will reduce people's real income, and they will need to work harder to achieve the same level of real income.


These two effects are contradictory. If the income effect is greater than the substitution effect, an increase in taxes will lead to more labour being supplied. If the substitution effect is greater than the income effect, an increase in taxes will lead to less labour being supplied.

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Government Expenditure

Areas of expenditure: social protection (£245bn), health (£149nb), education (£102bn), defence, debt interest, transport.


Government expenditure generally exceeds taxation revenue, even when the economy isn't in recession (structural deficit).

Cyclical deficit occurs when spending exceeds tax revenue because of the business cycle e.g. when the economy is in a recession.

Largest component of the budget is social protection (transfer payments) because there are so many low paid workers. This is called automatic stabilisers- prevent a recession by lowering tax and raising benefits.

Expenditure has also increased in transport, education and health. Debt interest has also increased because the government keeps selling more bonds and the national debt is £1.7tr.

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Areas of Government Expenditure

Capital spending- investment in infrastructure that is meant to last a long time and improve future productive capacity/growth e.g. roads, weapons, hospital and school buildings.

Current spending- spending on public sector workers' salaries, health service. Day to day running expenses of the public sector.

Transfer payments- payments made to people who are not productive in an economic sense e.g. pensions, JSA, benefits. Money is transferred from those who produce goods/services to those who don't.


Public goods- goods that could not be provided effectively through private businesses due to the free-rider problem. The government provides them so everyone has equal access to these necessary services e.g streetlights.

Merit goods- goods that would be under consumed and underprovided if left to private businesses. We need a government to make decisions on how much we need to consume and when e.g. NHS.

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Inflation: a sustained increase in the cost of living or the general price level leading to a fall in the purchasing power of money.

Deflation: a sustained fall in the price level. This occurs when inflation is negative.


Rate of inflation is measured by the annual percentage change in consumer prices. British government has set a target of 2% CPI (Consumer Price Index).

The Bank of England can increase the base rate to reduce inflation.

Increasing income tax, decreasing VAT and decreasing government spending on capital and current can reduce inflation.

Real terms is the value of goods/services at constant prices and has been adjusted for the effects of inflation. Money terms is the value of wages, interest, GDP etc. measured at current prices.

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Measuring Inflation

Inflation is measured by the Living Costs and Food Survey who survey households on what they typically purchase and how much they spend on it. Using this information, they make a basket of approximately 700 goods, which represents the typical purchases of the average household. It is a weighted index to reflect the relative importance of each item e.g. petrol is more than tobacco, so it is given a larger weighting.


Limitations of the CPI as a measure of inflation:

Few households are average- published figure is rarely the actual rate of inflation experienced by different people.

Not accurate for non-typical households e.g. people who don't own cars.

Spending patterns are different e.g. single people purchase different things to households with children.

Although the price of a good may rise, its quality may improve. This isn't recorded by the CPI.

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Types of Inflation

Cost-push: occurs when businesses respond to rising COPs by raising prices to maintain profit margins. Rising imported raw material costs (imported inflation), rising labour costs (wage rate spiral), higher indirect taxes imposed by the government).

Demand-pull: caused by increases in AD brought on by increased government spending and individual spending. If demand is greater than supply, prices will rise as businesses realise there is sufficient demand to merit higher prices.

Expectations-induced inflation: if people expect prices to keep rising, they are likely to increase their demand today for the goods they expect will increase in price. Businesses use the increase in AD to justify raising prices. If this works in reverse it leads to deflation i.e. expect prices to keep falling.

Excess money supply: rapid growth of money supply perhaps as a consequence of increased borrowing if interest rates are low. People have more money, meaning they have more to spend. This fuels demand-pull factors as businesses raise prices because of increased demand.

These all cause rate of inflation to increase.

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Deflation and Hyperinflation

Deflation occurs when general price levels fall meaning price growth is negative. Good deflation is the result of productivity improvements and competition. Bad deflation is the result of low demand forcing businesses to drop prices to attract more consumers. Consumers delay expenditure, waiting for better deals so businesses lose out on sales revenue. Contracts are delayed because of the uncertainty and risks of sudden price falls. Saving increase as consumers wait for more price falls. Businesses won't need to produce as many goods/services so they won't hire as many factors of production, leading to a negative multiplier effect.


Hyperinflation refers to instances of extremely high inflation. It can be devastating for an economy- the use of money is threatened. People resort to trading in petrol vouchers and cigarettes- reverting to a barter economy. Most historical examples have been aggravated by governments printing more bank notes. Germany 1923- 85billion% and Zimbabwe- 231million%.

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Effects of Inflation

On individuals: workers are made off in real terms, may discourage spending and may push families further into poverty. Workers can lose jobs if other countries are cheaper and businesses want to lower costs. Reduces real income of those on fixed incomes. Falling standards of living. People may resort to 'shoe leather shopping'. Reduces real value of interest rates- bad for saving, good for borrowing. Reduces disposable incomes of those on low wages.


On firms: UK firms lose international competitiveness. COPs rise so firms are less profitable. Higher prices may result in a fall in sales, less profitable. Uncertain about future costs and prices- may cancel future proposed extension plans as they don't know what it will cost them. Menu costs (have to change prices on menus, brochures, websites, price lists).


On the economy: balance of payment may deteriorate- goods more expensive and less competitive. Fewer exports, more imports lead to rising unemployment, bigger strain on public spending- more people need benefits and fewer pay income tax. Inflation causes inflation- wage rate spiral. Gap between rich and poor widens.

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To be classed as unemployed you have to be out of work and actively seeking work. If you aren't in work and don't want to be in work you don't count as unemployed. Official definition- someone who is not in work, has looked for work in the past 4 weeks and is ready to start work in the next 2 weeks.

How it is measured:

Labour Force Survey- involves asking 150,000 people if they are currently out of a job, actively seeking work and ready to immediately start work. Some unemployed people may not be eligible for JSA but are included in this measurement of unemployment. Conducted every quarter. Results are collated and extrapolated to represent whole population. More accurate of the 2 measures.

Claimant Count- measures number of people claiming benefits because they are out of work. Includes people on JSA and people claiming Universal Credit (people have to be seeking work to quality) each month. They must declare if they are unemployed, capable of work, available for work and seeking work the week the count in taken. Not as accurate as Labour Force Survey. However, people aren't included if they don't earn any of these because they haven't contributed enough to National Insurance while working, people who have a partner in work and still earn enough or people with enough money saved up.

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Unemployment Rate

The unemployment rate is the number of unemployed people as a percentage of all economically active people. Economically active- people who are in work or want to work.

Youth unemployment rate- unemployment rate specifically for people aged 16 to 24. Includes people who are looking for work and people who are still in full-time education looking for a part-time job. In summer of 2017, this number was 11.9%.

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Inaccuracies when Measuring Unemployment

Discouraged workers- workers who have been unemployed for a long time and may have stopped applying for jobs will be missed by the unemployment measures (disguised/hidden unemployed).

Economically inactive- people who are not actively looking for work because:

They need to look after elderly or infirmed relatives.

Parents who are full-time carers for their children.

People who have taken early retirement.

Under-employment: a country's data may ignore the extent of under-employment, for example people who want full-time work but have to settle for a part-time job.

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Types of Unemployment

Structural- long-term decline in demand in an industry leading to fewer jobs being available as demand for labour falls away. Leads to a decline in a particular sector or occupation e.g. coal mining.

Cyclical- involuntary unemployment due to a lack of demand for goods and services. Often caused by recessions or steep slowdowns in growth. Also called demand-deficient unemployment or Keynesian unemployment.

Frictional- transitional unemployment as people move between jobs e.g. newly-redundant workers or people who have just left university and take time looking for jobs.

Seasonal- unemployment caused by changes in demand for workers during the seasons e.g. Edinburgh Fringe and festival time needs more workers.

Regional: when structural unemployment affects local areas of an economy.

Real Wage: when wage rates are excessive, there will be a surplus supply of labour. However, if wage rates fall, people may not want to work at the equilibrium rate so there is unemployment.

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Why Unemployment is Low

Falling real wages makes it more affordable for firms to hire workers.

Firms are hiring more people on zero hour contracts.

Workers are cheaper than capital equipment so firms may look to hire more workers.

Benefit changes make it harder to get JSA, encouraging people to look for work.

There has been a rise in disguised unemployment and under-employment.

The number of self-employed workers has increased in the 'gig economy'.

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Effects of Unemployment

On individuals: loss of earnings leading to decline in spending power and rise of falling into debt problems. Potential homelessness if people don't have enough money to meet housing costs. Those who are unemployed will find it harder to find work in future as they have to compete against more people, firms prefer to employ people fresh out of work as training costs may be lower. Stress and health problems are higher amongst unemployed. Reduced status- may have to get benefits or take jobs you don't want to or that are 'beneath you'.

On firms: less profit as there is less demand for goods. VAT may rise to raise taxation revenue. Layoff penalties may be set to reduce number of people being made redundant. Loss of morale in workforce, could lead to demotivation. May be impacted by social problems e.g. crime. Larger pool of people to choose from and may be able to pay them lower wages.

On economy: negative multiplier effects as people are no longer earning incomes, spending it on goods. Loss of output, GDP operating well below productive potential and withing PPC, waste of scarce resources. Government loses out as they receive less taxation revenue but have to pay more benefits, increase taxation or increase budget deficit. Social costs- people may resort to crime, lower life expectancy, worse health. Widening of inequalities of income. Bigger pool of labour leads to less wage pressure and lower risks of industrial action.

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Policies to Reduce Unemployment

Monetary- lower interest rate makes it less attractive to save, but borrowing increases. These result in people having more money to spend so they can demand more. As demand has increased, firms will look to employ more people to produce more output to maximise profits.

Fiscal- lower VAT and income tax. People have more money to spend, they can demand more. As VAT decreased, goods may be cheaper so more people may be able to afford it. These increase demand, so firms may look to employ more people. Increasing capital spending will increase AD, meaning firms will hire more people.

Supply-side: increase spending on education and training, more highly skilled workforce which is more attractive to employers. Allows firms to employ more as they will still make profits despite COPs rising. Increased spending on housing improves geographical mobility. Allows workers to be able to move to find jobs without having to worry about housing. Lower benefits incentifies people to look for work.

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The Budget

Budget deficit- when the government spends more money than it receives in taxation revenue during one financial year- £60bn.

Budget surplus- when the government receives more money than it spends in one financial year.

National debt- the total of all the money a country owes as a result of them borrowing money- £1.7tr.

The Budget involves only government spending and taxation changes.

Recession- 2 consecutive quarters of negative economic growth. Results in a fall in AD and output, decreasing sales revenue and profit.

Budget deficits are almost inevitable during recessions because firms may be put out of business as they have lost so much demand so the government will receive less corporation tax revenue. People are unemployed so they aren't earning incomes, less income tax revenue and VAT revenue. The government will have to spend more money on benefits to provide incomes, and capital spending to cause a multiplier effect to get out of the recession.

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