Economics (Macro)

2.1

Measures of Economic Growth

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2.1.1

Economic Growth

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What is economic growth?

The rate of change of output. It is an increase in the long term productive potential of the country which means there is an increase in the amount of goods and services that a country produces

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How is economic growth measured?

It is typically measured by the percentage change in real GDP per annum

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What is GDP?

Gross Domestic Product - It is the total value of goods and services produced in a country within a year

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What is the difference between Total GDP and GDP per Capita?

Total GDP represents the overall GDP for the country whilst GDP per capita is the total GDP divided by the number of people in a country

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How does GDP per Capita grow?

GDP per capita grows if national output grows faster than population over a given time period, so there are more goods and services to enjoy per person

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What is the difference betwen Real GDP and Nominal GDP?

Real GDP strips out the effects of inflation whilst nominal GDP does not

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What is GNI?

Gross National Income - GDP + Remittances (money sent by people living, working overseas back to their country of origin)

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What is GNP?

Gross National Product - value of goods, services produced in the UK by British firms and British firms abroad

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What is meant by Purchasing Power Parities?

An exchange rate of one currency for another which compares how much a typical basket of goods in the country costs compared to one in another country

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What is useful about a PPP?

They are useful when comparing countries as it takes into account the cost of living

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What are six key factors affecting welfare?

Real GDP per capita, health, life expectancy, having someone to count on, perceived freedom to make life choices, freedom from corruption and generosity

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2.1.2

Inflation

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What is inflation?

A sustained general rise in prices across an economy

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What is deflation?

A sustained general fall in prices across an economy

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What is disinflation?

A fall in the rate of inflation

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How is inflation calculated?

Inflation is calculated using the Consumer Price Index (CPI) and the Retail Price Index (RPI)

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What is the process of CPI?

The ONS collects prices on 710 goods and services, the prices are updated every month, with collectors visiting the same retailers to monitor identical goods. All these prices are combined with the average household spending pattern to produce a CPI

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How is the average household spending worked out?

The average household spending is worked out through the Living Costs and Food Survey, where around 5,500 families keep diaries of what they spend over a fortnight

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What are limitations of CPI?

It does not include the price of housing; It is impossible for the figure to take into account every single good that is sold in the country and so therefore the CPI is not totally representative

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Why is CPI generally lower than RPI?

CPI takes into account the fact that when prices rise people will switch to product that has gone up by less. Therefore, the CPI is generally lower than the RPI

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What is the difference between CPI and RPI?

RPI includes housing costs and excludes the top 4% of income earners and low income pensioners

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What causes inflation?

Too much demand in the economy or rising costs as well as an increase in aggregate demand

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What is the first cause of inflation?

Demand-pull inflation - it is when there is too much demand, the price level is pressured to rise

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What is the second cause of inflation?

Cost-push inflation - whilst an increase in aggregate demand can push prices up, a decrease in aggregate supply may also push prices up. When businesses find their costs have risen, they will put up prices to maintain their profit margins

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What is the third cause of inflation?

Another potential cause of inflation is there being too much money in the economy. If people have access to money they will want to spend it but if there is no increase in the amount of goods and services supplied, then prices will have to rise

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What is the first effect of inflation on consumers?

If people’s incomes do not rise with inflation then they will have less to spend, which could cause a fall in living standards

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What is the second effect of inflation on consumers?

Those who are in debt will be able to pay it off at a price which is of cheaper value, but those who are owed money lose because the money they get back is of cheaper value. Consumers who have saved will lose out as their money is worth less

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What is the third effect of inflation on consumers?

Because prices are rising, they may feel less well-off, even if their income is rising in line with inflation, and so this may cause them to decrease their spending

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What is the first effect of inflation on firms?

If inflation in Britain is higher than other countries, British goods will be more expensive. They will become less competitive and make them more difficult to export

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What is the second effect of inflation on firms?

Deflation isn’t good as it encourages people to postpone their purchases as they wait for the price to fall further. People will be more likely to save as the value of their money will rise in the future

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What is the third effect of inflation on firms?

In general, inflation/deflation/disinflation is difficult to predict and so this means that firms cannot plan for the future

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What is the first effect of inflation on the government?

If the government fails to change excise taxes (taxes at a set amount e.g. £1) in line with inflation then real government revenue will fall

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What is the first effect of inflation on workers?

If workers do not receive yearly pay rises of the rate of inflation, they will be worse off and their living standard will decrease. Those in weaker unions tend to be most affected as they are unable to win wage rises in line with inflation

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What is the second effect of inflation on workers?

Deflation could cause some staff to lose their jobs as there is a lack of demand meaning firms see a fall in profit and have to decrease staff to cut costs

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2.1.3

Employment and Unemployment

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How is unemployment a good indicator of a country's economy?

Unemployment represents a waste of resources and so the level of unemployment is a good indicator of a country’s economy. Employment tends to be linked to economic growth as fast economic growth will lead to more jobs being created

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What is the claimant count?

The Claimant Count is the number of people receiving benefits for being unemployed. It provides the number of claimants on particular day each month and the numbers joining and leaving the count each month

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In terms of the International Labour Organisation (ILO), what does it mean to be employed?

Those who do more than 1 hour of paid work a week or are temporarily away from work, are on a government supported training scheme or do minimum 15 hours of unpaid work for their family business

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In terms of the ILO, what does it mean to be unemployed?

Those of working age who are without work, able to work and seeking work and have actively sought work in the last 4 weeks and are available to start work in the next 2 weeks

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In terms of the ILO, what does it mean to be inactive?

Those who are neither employed nor unemployed; they are people of working age not seeking employment as well as those seeking employment but not able to start work

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What is the Labour Force Survey?

Asks questions about personal circumstances and activity in the labour market to class people as employed, unemployed or inactive by the ILO definitions

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What is meant by the term economically active?

The economically active are the employed and unemployed. They are engaged in labour market and are people employers can look to recruit. The workless are the unemployed and inactive

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What is meant by the term employment rate?

The employment rate is the percentage of the population of working age who are employed, and the unemployment rate is the percentage of the economically active who are unemployed

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What is meant by the term participation rate?

The activity/participation rate is the percentage of the population of working age who are economically active whilst the inactivity rate is percentage of the population of working age who are inactive

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What does it mean to be underemployed?

Those who are in part time or zero hour contracts when they would prefer to be full time and people who are self-employed but would rather be employees

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Why does underemployment tend to increase during recessions?

Underemployment tends to increase during recessions because firms will just reduce staff hours instead of making them redundant and having to pay expensive redundancies packages

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What is frictional unemployment?

Frictional unemployment is due to people moving between jobs. This could be due to new workers entering the labour market or people who have chosen to leave their previous job. These people may take a while to locate and gain a job that they are will

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What would lengthen the duration of frictional unemployment?

Imperfect information - the jobless are unaware of the available jobs; incentives problems - some may not accept paid jobs if they believe the benefit system gives them sufficient income

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What is structural unemployment?

It is where the demand for labour is lower than the supply in an individual labour market. A prime cause is international competition and the search for cheap labour

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What is a big problem with structural unemployment?

The lack of geographical and occupational mobility means that people will remain unemployed, so need to be retrained in order to gain a job

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What are the three types of structural unemployment?

Regional - where certain areas of a country suffer from very low levels of employment due to industry closures; Sectoral - where one sector suffers a dramatic fall in employment; Technological - improvement in technology means that jobs are replaced

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What is seasonal unemployment?

Unemployment that occurs during different spells of the year. It is due to changing demand patterns

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What is cyclical/demand deficient unemployment?

When there is a recession or severe slowdown in economic growth, we see a rising unemployment because of firm closures and an increase in redundancies. This is due to a general lack of demand of goods and services within the country

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What is real wage inflexibility?

This is unemployment considered to be the result of real wages being above their market clearing level leading to an excess supply of labour

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How does migration affect jobs?

An increase in net inward migration tends to lead to increased jobs

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How does migration affect wages?

It leads to lower wages, particularly for lower-paid, low skilled jobs. UK firms are able to recruit foreign workers meaning that supply of labour is increased and so the price equilibrium of labour is reduced

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What are the effects of immigrant spending?

Due to the circular flow of income, immigrants’ spending creates jobs and total employment increases without an increase in unemployment

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What are the impacts of unemployment on workers?

Those made unemployed have a loss of income which results in a decline in living standard; they suffer from the stigma of being unemployed and feel degraded having to receive benefits; those who are in jobs will suffer from lower job security

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What are the impacts of unemployment on firms?

There will be a decrease in demand for their goods and so a fall in profit; long term unemployment can lead to loss of skills so firms have a smaller pool of skilled people to employ; they can offer low wages as people will take the job anyway

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What are the impacts of unemployment on consumers?

They suffer from less choice; the unemployed consumers lose out as they have less available to spend; firms may lower prices and put on sales in order to increase demand for their product

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What are the impacts of unemployment on the government?

The reduced income results in a fall in tax revenues and higher spending on welfare payments, incurring an opportunity cost as the money could be better spent elsewhere; this will result in an increase in the budget deficit

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What are the impacts of unemployment on society as a whole?

Rising unemployment is linked to social deprivation; areas of high unemployment often see a fall in demand for local goods and services, leading to a fall in income for those working in the services; it results in a loss of potential national output

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2.1.4

Balance of payments

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What is meant by the balance of payments?

The balance of payments is a record of all financial dealings over a period of time between economic agents of one country and all other countries. Imports - when goods come in, so money goes out. Exports - when money comes in, so the goods go out

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What is the balance of payments made up of?

The current account and the capital and financial account

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What is the current account made up of?

Trade in goods known as visibles because you can physically see them and trade in services known as invisibles

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What is the balance of trade?

The difference between visible exports and visible imports is known as the balance of trade

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What is the formula for current balance?

Current balance= Balance of trade + Balance of invisibles + Net income and current transfers

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What is meant by the current account (CA)?

The value of exports minus the value of imports (X-M) X= Exports (Money injected/Goods leave the UK) M= Imports (Money leaks/Goods enter the UK)

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What is a CA surplus?

When X>M

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What is a CA balance?

When X=M

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What is a CA deficit?

When M>X

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What four main objectives do governments tend to have?

High economic growth, low unemployment, low inflation and current account balance

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In terms of the objectives what does high economic growth mean?

It means we have high economic growth and low unemployment but will not achieve low inflation and a current account balance

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How has the world economy become more interconnected?

More technology being shared on a faster basis; there is increasing migration between countries; many more people own assets in other countries; the proportion of output of an individual economy which is traded internationally is growing

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2.2

Aggregate Demand

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2.2.1

The characteristics of Aggregate Demand

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What is aggregate demand (AD)?

The total level of spending in the economy at any given price

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What is the formula for AD?

AD = C + I + G + (X-M) C- Consumption/Consumer Spending I - Investment/Firms Spending G - Government Spending X-M - Net Exports/International Spending

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What does an AD curve show?

It shows the relationship between price level and real GDP, the AD curve is downward sloping as a rise in prices causes a fall in real GDP

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For what four reasons does the AD curve slope downwards?

The income effect; substitution effect; real balance effect and interest rate effect

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What is the income effect?

As a rise in prices is not matched straight away by a rise in income, people have lower real incomes so can afford to buy less, leading to a contraction demand

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What is the substitution effect?

If prices in the UK rise, less foreigners will want to buy British exports and more UK residents will want to buy imported foreign goods because they are cheaper. The rise in imports and fall of exports will decrease net exports so AD will contract

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What is the real balance effect?

A rise in prices will mean that the amount people have saved up will no longer be worth as much and so will offer less security. As a result, they will want to save more and so reduce their spending, causing a contraction in AD

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What is the interest rate effect?

Rising prices mean firms have to pay their workers more and so there is higher demand for money which leads to higher interest rates meaning that more people will save and less will borrow which means that businesses invest less, so AD will contract

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How is a movement along an AD curve caused?

A movement along the AD curve is caused by a change in prices , caused by inflation or deflation

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How is a shift in the AD curve caused?

A shift of the AD curve is caused by a change in any of the AD components

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2.2.2

Consumption

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What is consumption?

Consumption is spending on consumer goods and services over a period of time

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What is disposable income (Y)?

The money consumers have left to spend, after taxes have been taken away and any state benefits have been added

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What is meant by the marginal propensity to consume (MPC)?

How much an increase in income affects consumption

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Why do poorer people tend to have a higher MPC?

Poorer people tend to have a higher MPC as they are likely to spend much more of their increase in income whilst richer people are more likely to save it

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What is meant by average propensity to consume (APC)?

The average propensity to consume (APC) is the average amount spent on consumption out of total income

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What is the formula for MPC?

MPC= Change in consumption/ Change in income

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What is the formula for APC?

APC= Total consumption/ Total income

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What is meant by savings?

Savings is what is not spent out of income

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What is the relationship between consumption and savings?

An increase in consumption decreases savings

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What is meant by marginal propensity to save (MPS)?

How much of an increase in income is saved

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What is meant by the average propensity to save (APS)?

The average amount saved out of income

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What is the formula for MPS?

MPS= Change in savings/ Change in income

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What is the formula for APS?

APS= Total savings/ Total income

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How does interest rates affect consumption?

If interest rates are high, the price of the good will effectively be higher since more interest needs to be paid back and this will lead to a reduction in consumption. High interest rates also increase mortgage repayments so reduce consumption

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How does consumer confidence affect consumption?

If people are confident about the future and expect pay rises, then they will continue or increase their spending. If they expect high levels of inflation in the future, they will buy now as it will be at a cheaper price, so consumption will increase

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How does wealth effects affect consumption?

Wealth is the value of assets. People with greater wealth tend to have greater levels of consumption, known as the wealth effect: a change in consumption following a change in wealth

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How does distribution of income affect consumption?

Those on high incomes tend to save a higher percentage of their income than those on low incomes and so a change in the distribution of money in the economy will affect the level of consumption

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How does tastes and attitudes affect consumption?

There is a strong materialistic drive that encourages people to have the newest and the best and therefore spending can be very high, in some cases even above income. If people were less materialistic, consumption would decrease

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2.2.3

Investment

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What is meant by investment?

Investment is the addition of capital stock to the economy. It is only seen as investment if real products are created so buying a share in a company would be saving but buying new machinery is an investment

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What is meant by gross investment?

The amount of investment carried out and ignores the level of depreciation; all the spending that firms do

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What is meant by net investment?

Gross investment minus the value of depreciation; addition to the capital stock

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How does the rate of economic growth affect investment? (Accelerator Theory)

In a growing economy, there will be higher levels of investment as businesses would be more confident about their investments and the higher demand would lead to a higher return rate on the investment, this is known as the accelerator theory

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How does business expectations and confidence affect investment?

When businesses are confident about the future and expect future growth, investment will increase as they want to prepare for the future. If they are fearful of the future, then they will not invest money in new ideas or machinery - animal spirit

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How does demand for exports affect investment?

If the world economy is booming, demand for exports is likely to increase and therefore exporting firms’ investment is likely to increase to cope with this extra demand. This will have a knock-on effect and encourage other firms to increase theirs

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How does interest rates affect investment? (MEC Theory)

High interest rates mean that borrowing is expensive thus a business needs to be confident of good profits to cover the costs of borrowing. Keynes’ Marginal Efficiency of Capital (MEC) graph shows - higher interest rates lead to a fall in investment

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How does influence of government and regulations affect investment?

Governments can encourage investment by their own policy decisions. For example, they could offer tax breaks or grants to businesses to try and encourage them to invest

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How does access to credit affect investment?

Investment will be lower when an investment has a high risk attached to it, as it means there will be less access to credit and interest rates will be higher

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How does retained profit affect investment?

Retained profits are the profits kept by a firm and not shared with shareholders or used to pay taxes; if firms are making higher retained profits, investment is likely to increase as they have money available to invest

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How does technological changes affect investment?

Improvements in technology will improve or speed up production which will increase the level of profitability, meaning the investment has a better prospect of success

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How does costs affect investment?

A rise in the cost of any capital project increases the level of risk that you are taking and therefore leads to lower levels of investment

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2.2.4

Government Spending

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How does the trade cycle affect government expenditure?

In a recession, the government may increase spending to increase demand to reduce unemployment creating a budget surplus. During booms, the government may decrease spending to decrease demand and reduce inflation creating a budget deficit

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How does fiscal policies affect government expenditure?

Fiscal policy is the decisions about government spending and taxes and it will depend on the priorities of the government. The level of government spending depends on what they lay out in their fiscal policy

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How does age distribution of the population affect government expenditure?

An ageing population leads to increased government expenditure on pensions, social care etc. whilst a young population leads to increased spending on education. The more dependents in the economy (the young and old), the higher government spending

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2.2.5

Net Trade

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What is meant by net trade?

The total exports minus the total imports

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How does real income influence net trade?

When real income in the UK is high, there tends to be increased imports as people demand more goods and services and the UK is unable to meet their needs. This will mean that net trade decreases

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How does exchange rates influence net trade?

A strong pound makes imports cheap and exports dear because it costs foreigners more to buy pounds with their local currency. As a result, imports will increase and exports will decrease so net trade will decrease

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How does the state of world economy influence net trade?

If the UK’s main export country is doing well, then UK exports are likely to rise and so net trade is likely to rise

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How does the degree of protectionism influence net trade?

Protectionism is an attempt to prevent domestic producers suffering from competition abroad. If there is high protectionism on UK exports in other countries, exports will decrease as it will be hard for UK firms to sell their goods in other countries

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How does non-price factors influence net trade?

The two non-price factors are quality and design, marketing. If UK goods are of a high quality and design, well marketed exports will be high as foreign demand for UK goods will increase and imports will decrease meaning net trade will increase

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How does prices influence net trade?

High prices of UK goods will mean that the goods are less competitive compared to international goods since people make decisions partly based on price. This means the volume of exports will decrease and the volume of imports will increase

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2.3

Aggregate Supply

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2.3.1

The characteristics of Aggregate Supply

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What is meant by aggregate supply (AS)?

Aggregate supply is the volume of goods and services produced within the economy at a given price level

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What does AS indicate?

It indicates the ability of an economy to produce goods and services and shows the relationship between the real GDP and the average price levels

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What is short-run aggregate supply (SRAS)?

In short run, the factors of production are fixed and cannot be added to - you must make the most of what you have

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How can you get output increase in the short-run?

The only way is to make your current workforce work harder and so the costs are likely to rise with output and typically the increased costs is passed onto the consumer leading to a higher price

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What kind of elasticity would SRAS have?

It is likely to be elastic - this means that output is relatively responsive to a change in price

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What causes a movement along the SRAS?

Price changes always lead to a movement along the SRAS, price is the only factor that can cause movements

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What happens to the factors of production in the long run short run?

In the long run, all factors of production are variable but short run is the period of time when at least one factor of production is fixed and cannot be changed

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2.3.2

Short-run AS

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What is the main cause of a shift in SRAS?

The main cause of a shift in SRAS is a change in the cost of production

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How does changes in costs of raw materials and energy influence SRAS?

An increase in the cost of raw materials and energy increases the cost of production. This means the SRAS curve will shift left therefore businesses will only produce this amount of goods if prices rise

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How does changes in exchange rates influence SRAS?

A weaker pound will lead to an increase in the price of imports and this will cause SRAS to decrease as production becomes more expensive. If the pound becomes stronger, imports will be cheaper and so SRAS will increase

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How does changes in tax rates influence SRAS?

Taxes increase the cost of production and thus they cause a fall in SRAS, shifting it to the left. Subsidies shift it the curve right as they decrease costs

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2.3.3

Long-run AS

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What is the difference in terms of supply between long-run and short-run?

In the short run, supply can be increased by offering overtime but in the long run there will be a limit on how much supply can be increased

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What is a classical LRAS curve?

AS is independent of the price level and is determined by the level of all factors of production and the quality of technology.

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Why is a classical LRAS curve vertical?

The vertical AS curve is based on the classical view that markets tend to correct themselves fairly quickly. This means an economy v

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What is a Keynesian LRAS?

The curve is perfectly elastic but then becomes perfectly inelastic when operating at YFE meaning there is maximum utilisation of resources. Anything before YFE is when there is spare capacity but as we approach YFE resources become more scarce, dear

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What does a shift to the right on a Keynesian LRAS mean?

A shift of the LRAS to the right means that economies are able to produce more and is the same as an outward shift of the PPF

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How does technological advances influence LRAS?

Improvements in technology shift the LRAS curve to the right, meaning more can be produced. This is because it will speed up production, so more goods can be produced with the same amount of resources

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How does changes in relative productivity influence LRAS?

: The more productive the economy is, the more that will be produced with the given resources. Also, if the UK is more productive than other countries it will encourage production of that good in the UK, so investment and LRAS will be increase

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How does changes in education and skills influence LRAS?

A more skilled workforce will be more employable and work quicker and more efficiently within their jobs, so the output per worker will increase, which will shift the LRAS to the right

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How does changes in government regulations influence LRAS?

They can increase the size of the workforce which shifts LRAS because it means there are more resources in the economy and so more can be produced. They could make it easier to set up businesses which would increase jobs and output so LRAS increases

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How does demographic changes and migration influence LRAS?

If immigration is higher than emigration, the population will grow and so therefore there will be more workers which will increase the LRAS. The more people who are of working age, the higher the LRAS

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How does competition policy influence LRAS?

he government can promote competition between businesses and markets which will force them to improve the quality of their goods or lower prices. to do this and still make a profit, businesses have to improve their efficiency which will increase LRAS

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2.4

National Income

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2.4.1

National Income

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What is the circular flow of income?

Households lend FOPS to firms in return for goods and services the firms produce and so households also give payment for goods and services with firms giving households factor rewards in rent, wages, interest and profit

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In the circular flow of income what ways are there to measure the level of economic activity?

the national output, the value of the flow of goods and services from firms to households; the national expenditure, the value of spending by households on goods; the national income; of income paid by firms to households in return for FOPS

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What can be assumed with the circular flow of income model?

In this simple model, the national output=national expenditure=national income O=E=I

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What are the injections that go diagonally inwards on the circular flow of income?

The injections are: G (Government spending), I (Investment), X (Exports)

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What are the leakages that go diagonally outwards on the circular flow of income?

The leakages are: T (Taxation), S (Savings), M (Imports)

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What is wealth?

Value of assets (something you won)

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What is income?

The flow of money into households

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2.4.2

Injections and Leakages

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What does the balance of leakages and injections represent?

If the sum of injections is greater than the sum of leakages, then the economy will be growing whilst if injections are smaller than leakages, it will be shrinking. n an equilibrium, injections must be equal leakages and so the national income

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What are injections?

njections are monetary additions to the economy

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What are leakages?

Leakages are where money is removed from the economy

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2.4.3

Equilibrium levels of real national output

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What is the equilibrium position of national output?

Where the AD and AS curves intersect

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What do both Keynesian and Classical economists agree with in terms of short term?

Both Keynesian and Classical economists agree that in the short run AD will be downward sloping and AS will be upward sloping

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What do classical economists believe in terms of long run?

As the classical LRAS curve is perfectly inelastic a shift of the AD curve would not affect long run national output and would only affect price levels. lassical economists believe that the economy will always return to full employment level

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What do classical economists conclude?

They conclude that an increase in AD will increase price and output in the short run but over time, prices will continue to rise as the economy moves back to the long-term equilibrium and the only way to increase output is by increasing the LRAS

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What do classical economists believe in terms of AS?

A rise in long run aggregate supply is likely to lead to lower prices and higher output

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What policies do classical economists favour?

classical economists favour supply-side policies over demand management

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What is different about what Keynesian economists believe?

they believe there can be equilibrium at less than full employment- where the curve is horizontal. This is because they don’t believe that a rise in unemployment rapidly leads to a fall in real wages

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What do Keynesian economists believe should occur during recessions?

y Keynesians argue that during recessions the government needs to work to increase AD rather than using supply side policies

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2.4.4

The Multiplier

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What is the multiplier process?

The multiplier process is the idea that an increase in AD because of an increased injection can lead to a further increase in national income. It is the ratio of the final change in income to the initial change in injection

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What determines the size of the multiplier?

It will be determined by how much of an increase in income people will spend, the marginal propensity to consume (MPC). The lower the leakages, the higher the MPC, the bigger the multiplier

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What is an effect of the multiplier on an economy?

The multiplier means that growth can occur quicker, as any injections lead to a bigger increase in national income. Injections can be targeted at those with the biggest MPC in order to increase the size of the multiplier

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What is the Marginal propensity to consume (MPC)?

The increase in consumption following an increase in income

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What is the Marginal propensity to save (MPS)?

The increase in savings following an increase in income

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What is the Marginal propensity to tax (MPT)?

The increase in taxation following an increase in income

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What is the Marginal propensity to import (MPM)?

The increase in imports following an increase in income

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What is the relationship between the multiplier and MPC?

The higher the MPC, the bigger the multiplier as this means more money of income is spent so more money is transferred through the circular flow and less is withdrawn

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What is the marginal propensity to withdraw (MPW)?

The increase in leakages following an increase in income MPW = MPS + MPT + MPM

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What is the formula for the multiplier?

Multiplier = 1/1-MPC = 1/MPW

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What is the effect of the multiplier on AD?

The multiplier leads to an increase in AD higher than the original increase but for it to have the desired effect, there must be sufficient spare capacity in the economy for extra output to be produced

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How does the elasticity of a LRAS curve affect the impact of the multiplier?

The more elastic the curve, the smaller the effect on price but the bigger the effect on output

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Generally what is the effect of the multiplier?

The multiplier will have a big effect when there is lots of spare capacity in the economy and the MPW is low/MPC is higher; has little effect on output when there is little spare capacity in an economy so the rising demand only creates rising prices

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2.5

Economic Growth

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2.5.1

Causes of Growth

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How does economic growth occur?

For economic growth to occur, there needs to be an increase in quality or quantity of one of the four factors of production: land, labour, capital or enterprise, or these being used more efficiently

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How would a change in land allow economic growth to occur?

The discovery of new resources e.g. oil will increase economic growth

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How would a change in labour allow economic growth to occur?

An increase in the quality or quantity of labour will improve economic growth, this can be the size or quality of the workforce

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How would a change in capital allow economic growth to occur?

If a country receives sustained investment, they will be able to access or develop new technology which will enable the country to improve productivity. It will also mean more machines can be bought and used

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How would a change in enterprise allow economic growth to occur?

f the government offers tax benefits and grants, they will encourage the development of business, creating jobs and meaning more goods and services are produced, which will increase economic growth

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How would a change in technological progress allow economic growth to occur?

Improved technologies mean that the average cost of production is lower, whether this is because it is quicker to produce or less labour or equipment is needed

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How would a change in efficiency allow economic growth to occur?

: Efficiency is important in bringing about economic growth as it means less resources are needed to produce each good, so more goods can be produced

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What is actual growth?

ctual growth is the percentage change in GDP. It is when the economy is actually produced more goods and services

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What is potential growth?

the change in productive potential of the economy over time, so the LRAS or PPF curve shifts

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What does a PPF show?

The potential output of an economy

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What do PPF shifts show?

An outward shift of the PPF is economic growth. If the economy moves from inside the PPF to on the PPF, this would be classed as economic recovery rather than economic growth

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What do many economists argue in terms of economic growth and AD?

Many economists argue that AD can affect economic growth, through export-led growth: a rise in AD through increased exports

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How does increased exports affect AS as well?

Although increased exports initially increases AD rather than LRAS, sustained high export levels will encourage, or force, firms to invest and increase demand for labour, which will lead to economic growth

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2.5.2

Output Gaps

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What is an output gap?

An output gap is the difference between the actual level of GDP and the estimated long-term value for GDP

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What is a positive output gap?

A positive output gap is when GDP is higher than estimated

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What is a negative output gap?

A negative output gap is when GDP is lower than estimated

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What can be inferred when there is a negative output gap?

With a negative output gap, there is spare capacity in the economy with factories, offices and workers not being utilised to produce goods and services

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What do classical economists say regarding positive output gaps?

Classical economists would argue that this positive output gap would be filled bylong-run economic growth moving the LRAS curve, a recession which woulddecrease AD or a rise in the costs of production which would decrease SRAS

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What do classical economists say regarding negative output gaps?

They would also argue that the negative output gap would be brought back to equilibrium by rising AD or a fall in SRAS due to lower costs of production

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2.5.3

Trade Cycle

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What is the trade cycle?

This is the periodic but irregular up and down movements in economic activit y, measured by fluctuations in real GDP and other macroeconomic variables

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What are the four phases of the trade cycle?

Boom, downturn, recession and recovery

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Why does the trade cycle exist?

It exists because of supply side and demand side shocks

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What are the characteristics of a boom?

national income is high and the economy is likely to be working above PPF where there is a positive output gap . Consumption and investment tend to be high as are tax revenues, and wages will be increasing

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What are the characteristics of a downturn?

Output and income fall which leads to a fall in consumption and investment as well as tax revenues. Payments for benefits rise as unemployment rises and a fall in the number of imports occurs

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What are the characteristics of a recession?

There tends to be high unemployment causing low consumption, investment and imports. Inflationary pressure will be low and there may even be deflation

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What are the characteristics of a recovery?

National income and output begin to increase with unemployment falling and consumption, investment and imports increasing. Inflationary pressure begins to grow as workers start to demand higher wages

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2.5.4

The impact of economic growth

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What is the impact of economic growth on consumers?

There will be an increase in demand for housing which will increase house prices; positive wealth effect; improved productive efficiency

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What is the impact of economic growth on firms?

Investment will increase; business confidence will improve; more research and development done; combination of higher demand and lower costs is likely to lead to higher profits

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What is the impact of economic growth on the government?

Tax revenues will rise as more goods and services are being bought; it can help to reduce the budget deficit

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What is the impact of economic growth on current and future living standards?

Lower poverty levels; more goods and services for people to enjoy; housing standards and the quality of food increases;

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2.6

Macroeconomic Objectives and Policies

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2.6.1

Possible macroeconomic objectives

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What is one objective the government has?

High economic growth

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What is a second objective the government has?

Low unemployment: aiming for an unemployment rate of around 3%

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What is the third objective the government has?

Low and stable inflation: in the UK, the government target is 2%

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What is the fourth objective the government has?

Balance of payment equilibrium on the current account

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What are three additional objectives the government has?

Balance government budget; protection of the government and greater income equality

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2.6.2

Demand-side policies

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What is meant by demand-side policies?

Demand side policies are policies designed to manipulate consumer demand

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What is meant by expansionary policy?

Expansionary policy is aimed at increasing AD to bring about growth

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What is meant by deflationary policy?

deflationary policy attempts to decrease AD to control inflation

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What is meant by monetary policy?

Monetary policy is where the central bank or regulatory authority attempts to control the level of AD by altering base interest rates or the amount of money in the economy

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What is meant by fiscal policy?

Fiscal policy is use of borrowing, government spending and taxation to manipulate the level of aggregate demand and improve macroeconomic performance

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What type of policy do interest rates come under?

Monetary policy

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What is one way in which interest rates cause a fall in AD?

The rise in interest rates will increase the cost of borrowing for firms and consumers. This will lead to a fall in investment and consumption, reducing AD

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What is a another way in which interest rates cause a fall in AD?

With more people saving there is a fall in demand for assets. This leads to a fall in prices for these assets . Therefore, consumers will experience a negative wealth effect as the value of their assets fall which will leads to a fall in consumption

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What is a third way in which interest rates cause a fall in AD?

People will become less confident about borrowing and spending if interest rates rise. The fall in consumer and business confidence leads to a fall in consumption and investment, causing a fall in AD

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What is a fourth way in which interest rates cause a fall in AD?

Higher rates will increase the incentive for foreigners to hold their money in British banks as they can see a higher rate of return causing imports to be cheap and exports to be dear which decreases net trade and therefore AD

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What are some problems with using interest rates to manage demand?

The exchange rate may be affected; changes in interest rates take up to 2 years to have their full effect; A lack of confidence in the economy may mean that, no matter how low interest rates are people will not spend

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What type of supply does quantitative easing come under?

Monetary supply

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What is quantitative easing?

This is when the Bank of England buys assets in exchange for money in order to increase money supply and get money moving around the economy during times of very low demand

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Where does the name quantitative easing come from?

‘Quantitative’ means a set amount of money is being created and ‘easing’ refers to reducing pressure on banks. It can prevent the liquidity trap, where even low interest rates cannot stimulate AD

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What is one way of buying assets for the Bank of England?

One way of buying assets is for the Bank of England to simply increase the size of banks’ accounts at the Bank of England, called the ‘reserves’, which encourages them to lend money

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In general what does quantitative easing do?

Quantitative easing has the effect of increasing consumption and investment, which increases AD and ensures the country meets its inflation target

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What is one way in which quantitative easing affect AD?

Since the bank is buying assets, there is a rise in demand and so asset prices rise . This causes a positive wealth effect since shares, houses etc. are worth more so people will increase their consumption

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What is another way in which quantitative easing affect AD?

The money supply increases. Private sector companies receive more money which they can spend on goods and services or other financial assets, which may increase investment or consumption and therefore increase AD

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What is another way in which quantitative easing affect AD?

Commercial banks may lower their interest rates as they are receiving so much money from the Bank of England and so can offer very low interest deals to their customers encouraging consumption and investment

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What is a problem with quantitative easing?

It is very risky and, if not controlled properly, could cause high inflation and even hyperinflation

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What is another problem with quantitative easing?

Others say it would only lead to increased demand for second hand goods which pushes up prices but does not increase aggregate demand

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What is another problem with quantitative easing?

There is no guarantee that higher asset prices lead into higher consumption through the wealth effect, especially if confidence remains low

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What is the role of the Bank of England?

Monetary policy is controlled by the Bank of England rather than the government. The Monetary Policy Committee (MPC) makes the most important decisions, including the Bank of England base rate and the actions over quantitative easing

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What is the main aim of the Bank of England?

Their main aim is keep inflation at 2% and if it goes below 1% or above 3% the governor of the Bank of England has to write a letter to the Chancellor of the Exchequer explaining why this is happened and what the Bank of England is doing to fix it

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What are the two main ways a government can affect AD through fiscal policy?

A rise in income tax and a rise in government spending

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How does a rise in income tax affect AD?

A rise in income tax will cause a fall in disposable income. This will lead to a reduction in consumption and thus decrease AD. Alternatively, a rise in corporation tax will decrease a firm’s post-tax profits. This will lead to investment falling

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How does a rise in government spending affect AD?

A rise in government spending will increase AD since it is one component

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What is a budget deficit?

A budget deficit is when the government spends more money than they receive

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What is a budget surplus?

A budget surplus is when the government receives more money than they spend

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What type of policy do indirect and direct taxation come under?

Fiscal policy

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What is a direct tax?

Direct taxes are paid directly to the government by the individual taxpayer

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What is an indirect tax?

An indirect tax is where the person charged with paying the money to the government is able to pass on the cost to someone else

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What are some problems with fiscal policy?

Government spending also impacts LRAS; taxes and spending have an impact on inequality, so some decisions aimed to reduce/increase demand may increase income inequality; the impact of fiscal policy depends on the multiplier

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What do classical economists argue?

Classical economists argue that any demand management, whether fiscal or monetary, will have no effect on long-run output so supply side policies should be used

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What is the biggest issue with demand-side policies?

The biggest issue of demand-side policies is that, in most cases, an expansionary policy is inflationary whilst a deflationary policy brings unemployment

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Why are monetary policies useful?

Monetary policy is useful as the government is able to increase demand without having to increase their spending, which would result in a larger fiscal deficit. Classicists argue that if demand management should only be done with monetary policy

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Why are fiscal policies useful?

Fiscal policy can have significant impacts on the supply side of the economy, for example increases in spending on education to increase AD will also increase LRAS. Moreover, it is more effective at targeting specific groups and reduce poverty

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2.6.3

Supply-side policies

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What are supply-side policies?

Supply side policies are government policies aimed at increasing the productive potential of the economy and moving the supply curve to the right

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What are market based policies?

Market based policies are policies which are designed to remove anything that prevents the free market system working efficiently, causing lower output and higher prices

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What are interventionist policies?

Interventionist policies are policies designed to correct market failure, for example the free market under provides education and so the government provides it

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What do free market economists argue when it comes to interventionist or market based policies?

Free market economists tend to argue for market-based policies as they want the government to have as small a role as possible

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What is one form of supply-side policy?

Increase incentives: By increasing the incentive for people to go to work or firms to employ people, the government will increase the size of the workforce and this would mean more goods and services would be produced

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What is a good example of increasing incentives?

A reduction in benefits/taxes will increase the opportunity cost of being out of work and mean that people are always better off within work than on benefits

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What is another form of supply-side policy?

Promote competition: Privatisation, selling nationalised companies to private sectors, or deregulation, reducing restriction on businesses which restrict entry to the market, makes firms more competitive

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What is the general idea behind promoting competition?

The belief is that competition is necessary to make firms efficient as they have to offer a cheaper or better service if there is competition

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What is another form of supply-side policy?

Reform the labour market: By increasing the retirement age, there will be more people working so more goods and services can be produced; the labour market could become more flexible in order to be more efficient as it can respond to external changes

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In general what does reforming the labour market do?

On the whole, all of these methods would reduce unemployment, which represents a waste of resources, and mean that more goods and services can be produced as the labour force is bigger

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What is another form of supply-side policy?

Improve skills and quality of the labour force: By increasing spending on education and training to create a more educated workforce who will be more efficient and be able to do more skilled jobs, it will increase goods and services produced

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What is another form of supply-side policy?

Improve infrastructure: This could be done through offering tax incentives or subsidies on investment; alternatively, the government could spend money to improve infrastructure themselves

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What is an evaluative point comparing demand-side and supply-side policies?

Unlike demand-side policies, supply side policies are able to both increase output and decrease prices

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What are benefits of supply-side policies?

They are more long-term policies and lead to long term economic growth, rather than small changes in economic growth following changes in AD and they can be directed at increasing exports which will also improve the balance of payments

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What is a downside of supply-side policies?

However, the Keynesian LRAS curve shows that they have no impact when LRAS is elastic, and so demand-side policies are needed to fix the problem in the short run

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What is another downside of supply-side policies?

Often, the government has to spend more money or decrease taxes, which will decrease their revenue and lead to a budget deficit and the policies take a long time to take effect

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2.6.4

Conflicts and trade-offs between objectives and policies

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What is the general problem with objectives and policies?

There are many different trade-offs between the macroeconomic objectives. Two objectives which tend to go hand in hand are economic growth and unemployment, but the rest tend to be achieved at the expense of another

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What is the conflict between economic growth and protection of the environment?

As the economy grows, we expect more resources to be used. As we use resources and produce goods, we produce pollution and noise and destroy habitats. Economic growth in China has been rapid but it has led to serious levels of pollution

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What is the conflict between economic growth and the balance of payments?

Some countries such as India have seen rapid economic growth leading to balance of payments problems. The country is so large that its industry is largely producing goods for its own people and the wealth of the people imports being demanded

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In comparison to India, how has China's growth been better?

In comparison, China has seen massive growth but that has been largely been by producing goods for exports and therefore their balance of payments is in a surplus

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What is the conflict between unemployment and inflation?

The Phillips Curve says that the rate of change in money wages increased as the rate of unemployment fell. Then it was generalised into a relationship between unemployment and inflation, by arguing that firms pass on increases in wages to consumers

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What is the conflict between expansionary and deflationary fiscal and monetary policies?

Expansionary policies will increase AD, to increase output, employment and economic growth but will lead to increased inflation and may worsen the balance of payments as some of the increased demand for goods and services will be met by imports

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What is the conflict between expansionary and deflationary fiscal and monetary policies? (continued)

On the other hand, deflationary policies will decrease AD to improve inflation but will decrease employment and economic growth

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What is the problem with changes in interest rates?

An increase in interest rates will be used to decrease inflation. However, continuously high rates will damage long-term investment as less businesses will want to invest, and this will decrease long-term growth

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What is another problem with changes in interest rates?

Moreover, they will raise the value of the pound which will decrease exports and increase imports, worsening the balance of payments and low interest rates increase income inequality

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What is a problem with supply-side policies?

Supply side policies intend to increase aggregate supply, and therefore improve long term economic growth. They are also able to decrease long term inflation but may increase it in the short term if they encourage investment as this will increase AD

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What is another problem with supply-side policies?

Policies which decrease trade union power, reduce wages, lower benefits, change taxation may increase income equality as these will negatively affect the poorest in the country. Supply-side policies have adverse effects on the budget or environmental

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What is a problem with fiscal deficits?

In order to reduce fiscal deficits, the government may decide to reduce government spending and increase taxes. Firstly, this will reduce AD and decrease short term economic growth and higher unemployment

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4.1

International Economics

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4.1.1

Globalisation

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What is globalisation?

Globalisation refers to the growing interdependence of countries and the rapid rate of change it brings about

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What does the OECD define globalisation as?

the ‘geographic dispersion of industrial and service activities, for example research and development, sourcing of inputs, production and distribution and the cross border networking of companies, for example through joint ventures

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What are factors contributing to globalisation?

Improvements in transport infrastructure and operations; improvements in IT and communication; trade liberalisation; international financial markets and TNCs

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What are the impacts of globalisation on consumers?

Consumers have more choice; can lead to lower prices; in other cases, it is leading to a rise in prices since incomes are rising; consumers worry about the loss of culture

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What are the impacts of globalisation on workers?

Some people have gained jobs whilst others have lost; increased migration may affect workers by lowering wages but migrants can also provide important skills and an increase in AD; the wages for high skilled workers appear to be increasing

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What are the impacts of globalisation on producers?

Firms are able to source products from more countries; they are able to employ low skilled workers much cheaper in developing countries and can exploit comparative advantage; firms who are unable to compete internationally will lose out

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What are the impacts of globalisation on the government?

The government may be able to receive higher taxes; TNCs also have the power to bride and lobby governments; if the government uses the correct policies, they can maximise the gains and minimise the losses

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What are the impacts of globalisation on the environment?

Increase in world production has led to increased demand for raw materials; increased trade and production has also led to more emissions; globalisation means the world can work together to tackle climate change

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What are the impacts of globalisation on economic growth?

Globalisation increases investment within countries; TNCs may bring world class management techniques; trade will increase output; the power of TNCs can cause political instability

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4.1.2

Specialisation and trade

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What does the theory of comparative advantage state?

The theory of comparative advantage states that countries find specialisation mutually advantageous if the opportunity costs of production are different . If they are the same, there will be no gain from trade

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When does absolute advantage exist?

Absolute advantage exists when a country can produce a good more cheaply in absolute terms than another country

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When does comparative advantage exist?

Comparative advantage exists when a country is able to produce a good more cheaply relative to other goods produced

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For comparative and absolute advantage...

Make sure you know how to interpret and analyse both the diagrammatic and numerical approaches

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What are some assumptions of the absolute and comparative advantage theory?

Comparative advantage assumes there are no transport costs; it also assumes costs are constants and that there are no economies of scales; in the model, goods are assumed to be homogenous, which is unlikely to hold in real life

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What are other limitations of the absolute and comparative advantage theory?

It also assumes that factors of production are perfectly mobile , there are no tariffs or other trade barriers and there is perfect knowledge; whether trade takes place will depend on the terms of trade between the countries

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What is one advantage of specialisation and trade?

Comparative advantage shows how world output can be increased if countries specialise in what they are best at producing, this will increase global economic growth

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What is another advantage of specialisation and trade?

Trading and specialising allows countries to benefit from economies of scale , which reduces costs and therefore decrease prices globally

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What is another advantage of specialisation and trade?

Different countries have different factors of production and so trade allows countries to make more effective use of these factors of production

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What are other advantages of specialisation and trade?

Trade enables consumers to have greater choice about the types of goods they buy, and so there is greater consumer welfare; trade also means there is greater competition, which provides an incentive to innovate

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What are disadvantages of specialisation and trade?

Trade can lead to over-dependence; it can cause structural unemployment, as jobs are lost to foreign firms who are more efficient and competitive; the environment will suffer;

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What are other disadvantages of specialisation and trade?

Countries may suffer from a loss of sovereignty due to signing international treaties and joining trading blocs; they may see a loss of culture as trade brings foreign ideas and products to the country

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4.1.3

Pattern of trade

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What is one factor influencing the pattern of trade?

Comparative advantage - countries will trade where there is a comparative advantage to trading. A change in the comparative advantage will affect the trade pattern

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What is a second factor influencing the pattern of trade?

Emerging economies - emerging economies shift the trade pattern by taking up a larger proportion of a country’s imports and exports than they had previously

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What is a third factor influencing the pattern of trade?

Trading blocs and bilateral trading agreements - these increase the level of trade between certain countries and so influence the pattern of trade because trade increases between these countries and decreases between others

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What is a fourth factor influencing the pattern of trade?

Relative exchange rates - the exchange rate affects the relative prices of goods between countries. Prices are an important factor in determining whether consumers buy goods and so a change in price will affect the pattern of trade

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4.1.4

Terms of trade

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What does the terms of trade measure?

The terms of trade measures the rate of exchange of one product for another when two countries trade. It tells us the quantity of exports that need to be sold in order to purchase a given level of imports

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When is the movement in terms of trade favourable?

Movement in the terms of trades is said to be favourable if the terms of trade increase as the country can buy more imports with the same level of exports. This is called an improvement in the terms of trade

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When is the movement in terms of trade unfavourable?

It is unfavourable if the terms of trade decrease, when export prices fall or import prices rise. This is called a deterioration

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How is the terms of trade calculated?

(Average export price index/Average import price index) x100

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What is a factor influencing a country's terms of trade?

In the short run, exchange rates, inflation and changes in demand/supply of imports or exports affect the terms of trade since these affect the relative prices of imports and exports

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What is another factor influencing a country's terms of trade?

In the long run, an improvement in productivity compared to a country’s main trading partners will decrease the terms of trade since export prices will fall relative to import prices

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What is a third factor influencing a country's terms of trade?

Another long run factor is changing incomes. This affects the pattern of demand for goods and services

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How does productivity affect ToT?

If producitivity falls this means unit costs will rise and for firms to maintain profit margins they increase the prices of goods, services. As a result, the price of X improves and assuming the price of M is constant ToT improves

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How do exchange rates affect ToT?

If exchange rates improve then export prices rise as foreigners sacrifice more of their currency to buy one good. Consequently, the purchasing power of currency improves meaning imports are relatively cheaper causing ToT to improve

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What is the relationship between ToT and competitiveness?

As ToT improves, competitiveness worsens and vice versa

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Generally, what influences a country's terms of trade?

In general, anything which affects the price of a country’s imports or exports will affect its terms of trade

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What is one impact of changes in the terms of trade?

If PED of exports and imports is inelastic, a favourable movement in terms of trade would improve the current account on the balance of payments whilst if it is elastic, a favourable movement would worsen the current account

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What is a second impact of changes in the terms of trade?

An improvement in the terms of trade is likely to lead to a fall in GDP and a rise in unemployment, since if it is caused by a rise in export prices, exports will fall and if it is caused by a fall in import prices, imports will rise

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What is a third impact of changes in the terms of trade?

It is important to look at the cause of the change. If an improvement has occurred due to increased demand for exports or if a deterioration is caused by an improvement in international competitiveness, then this will be beneficial for the country

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4.1.5

Trading blocs and the World Trade Organisation

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What is a regional trading bloc?

A regional trading bloc is a group of countries within a geographical region that protect themselves from imports from non-members. They sign an agreement to reduce or eliminate tariffs, quotas and other protectionist barriers among themselves

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What do most regional trade agreements take the form of?

Most regional trade agreements take the form of bilateral agreements, between one single country and another single country. Some agreements are multilateral or plurilateral agreements, between at least three countries

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What is a preferential trading area (PTA)?

These are where tariff and other trade barriers are reduced on some but not all goods traded between member countries

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What is a free trade area (FTA)?

These occur when two or more countries in a region agree to reduce or eliminate trade barriers on all goods coming from other members. Each member is able to impose its own tariffs and quotas on goods it imports from outside the trading bloc

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What is a customs union?

A customs union involves the removal of tariff barriers between members and the acceptance of a common external tariff against non-members. This means that members may negotiate as a single bloc with third parties

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What is a common market?

This is the first step towards full economic integration and occurs when members trade freely in all economic resources so barriers to trade are removed. They impose a common external tariff on imported goods from outside the markets

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What is a monetary union?

These are two or more countries with a single currency, with an exchange rate that is monitored and controlled by one central bank or several central banks with closely coordinated monetary policy

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Why is a monetary union good?

Monetary unions are good since they mean prices are fixed as all currencies are the same and there are reduced exchange rate costs. It becomes easier for prices to be compared across the union and so MNCs are less able to price discriminate

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Why is a monetary union perhaps bad?

There are financial costs involved with starting the new currency and there would be costs if the union broke up. There is a loss of policy independence, countries are unable to change the value of their currency

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What is an economic union?

An economic union is the final step of economic integration. There will be a common market with coordination of social, fiscal and monetary policy

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What is an advantage of trading blocs?

Free trade encourages increased specialisation, and this increases output, according to comparative advantage. This specialisation also helps firms to benefit from economies of scale, causing lower prices and costs, a dynamic advantage

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What is another advantage of trading blocs?

Firms may be able to grow much larger by creating a larger customer market , but this may be difficult given different customer markets in different countries

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What is another advantage of trading blocs?

Firms inside the bloc are protected from cheaper imports from outside

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What are other advantages of trading blocs?

The increased trade may create more jobs; increased choice for consumers; Another dynamic benefit may be competition, as the removal of barriers means domestic industries face greater competition

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What is a disadvantage of trading blocs?

Countries are no longer able to benefit from trade with countries in other blocs and the blocs are likely to distort world trade , reducing the benefits of specialisation

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What is another disadvantage of trading blocs?

Inefficient producers within the bloc are protected from efficient producers outside the bloc, called trade diversion

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What is another disadvantage of trading blocs?

There may be a reduction in competition as inefficient firms are driven out of the business and the market becomes oligopolistic

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What are other disadvantages of trading blocs?

They lessen national sovereignty; one dynamic loss may be the loss of resources; There could also be retaliation as the creation of one regional trading bloc will lead to the creation of others and this can lead to trade disputes

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What is trade creation?

Trade creation is when a country moves from buying goods from a high cost to a lower cost country

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What is trade diversion?

Trade diversion is when a country goes from buying lower cost goods to a higher cost

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What does the costs and benefits of trading blocs depend on?

The costs and benefits of trading blocs will depend on whether they lead to trade creation or trade diversion

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When does trade diversion occur?

Trade diversion occurs where consumption shifts from a lower cost producer outside the trading bloc to a higher cost producer within it

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What is the diagram of trade creation?

The diagram is the opposite of the tariff diagram, since it removes the tariffs and leads to welfare gain and higher consumer surplus. It is when consumption shifts from a high cost domestic producer to a low cost partner producer

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What is the World Trade Organisation (WTO)?

The World Trade Organisation was set up in 1995 to replace the GATT, which had aimed to reduce protectionism

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What are the aims of WTO?

To bring about trade liberalisation and to ensure countries act according to the trade agreements they have signed

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What are conflicts with the WTO?

Regional trade agreements contradict WTO’s principles; some might argue the WTO is too powerful or that it ignores the developing countries

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4.1.6

Restriction on free trade

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One reason for restriction is the infant industry argument, what is meant by this?

An infant industry is one that is just being established within a country meaning their AC is higher. Therefore, the industry would be unable to compete in the international market and so the government protect them until they are able to compete on

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A second reason for restriction is job protection, what is meant by this?

Governments may be concerned that allowing imports will mean domestic producers will lose out to international firms, and so there will be job losses within the country

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A third reason for restriction is protection from potential jumping, what is meant by this?

Dumping is when a country or company with surplus goods sells these goods off to other areas of the world at very low prices, harming domestic producers in those countries. The government may need to intervene to protect domestic producers

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A fourth reason for restriction is protection from unfair competition, what is meant by this?

Domestic producers may be unable to compete with a firm that has very low labour costs or with a firm that is heavily subsidised by the government. Some will argue the government should intervene to protect domestic producers from this

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A fifth reason for restriction is terms of trade, what is meant by this?

If a country buys a large amount of imports for a good, this will increase demand for that good and hence increase the price. Restrictions will reduce supply of the good and lead to a fall in the price received by the importer, improving the terms

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A sixth reason for restriction is danger of over specialisation, what is meant by this?

Some people believe that no country should become totally reliant on another for important products or materials and so it is important to introduce protectionism on these goods to prevent firms and consumers becoming reliant on them

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A tariff is one type of restriction, what is a tariff?

These are taxes placed on imported goods which make them more expensive to buy, making people more likely to buy domestic goods

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Do you know the diagram for the imposition of a tariff?

Hopefully yes!

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Why are tariffs perhaps inefficient?

They are inefficient as they cause deadweight loss

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A quota is another type of restriction, what is a quota?

These are limits placed on the level of imports allowed into a country , meaning people are forced to buy domestic goods if they want that good and the quota is already used up

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Do you know the diagram for the imposition of a quota?

Hopefully yes too!

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Subsidies to domestic products are another type of restriction, what is meant by this?

These are payments to domestic producers which lower their costs and help them to be more competitive by enabling cheaper prices

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Non-tariff barriers are another type of restriction, what is meant by this?

Countries can introduce an embargo - a total ban on imported goods or they can introduce import licensing when firms need a license to be able to import and by reducing the number of licenses they give out, the government can restrict imports

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What are the impacts of protectionist policies on consumers?

Higher prices as they are unable to buy imports at the cheaper price, it tends to raise the price of domestic producers since goods and services needed for the production of these goods may also suffer from import controls. Also there is less choice

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What are the impacts of protectionist polices on producers?

Domestic producers tend to benefit from import controls since they have less competition so can sell more goods at a higher price, however they may suffer from higher costs if there are controls on the imports they need for production

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What are other impacts of protectionist policies on producers?

Foreign producers will lose out as they are limited in where they can sell their goods. Inefficient, domestic producers are kept in production, whilst efficient, foreign ones lose out

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What are the impacts of protectionist policies on workers?

Evidence suggests there is little difference to employment. It can be argued that allowing inefficient firms to close would be better for workers in the long run. The market would reallocate resources and create new jobs, with greater security

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What are the impacts of protectionist policies on governments?

In the short run, governments benefit from protectionist policies as they can gain tariff revenues and they are politically popular. However, it can lead to an inefficient economy which stifles growth

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What are the impacts of protectionist policies on living standards?

As the tariff diagram shows, the imposition of import controls results in deadweight welfare loss. It also causes trade wars since the introduction of restrictions often leads to retaliation by other countries

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What are the impacts of protectionist policies on equity?

It has a regressive effect on the distribution of income as the rise in price affects the poorer members of society far more than the well off as it is they are no longer able to afford the products

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What did the financial crisis and recession lead to in terms of protectionism?

The financial crisis and recession led to distrust of globalisation and pressure to put self-interest above anything else. Countries have found it difficult to lower protectionism since they always expect reciprocity

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4.1.7

Balance of payments

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What is the balance of payments?

A country who participates in foreign trade will be sending and receiving money from other countries and they keep track of these transactions in a balance sheet, called the balance of payments

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One component of the balance of payments is the current account, what is this?

The current account itself is split into different parts: trade in goods, trade in services and income and current transfers

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Another component of the balance of payments is the capital account, what is this?

The capital account is relatively unimportant as it mainly records transfers of immigrants and emigrants taking money abroad or bringing to the UK, or government transfers such as debt forgiveness to Third World countries

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Another component of the balance of payments is the financial account, what is this?

The financial account is more important and is split into three main parts: foreign direct investment (FDI), portfolio investment and other investments

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What is meant by FDI?

Foreign direct investment is the flow of money to purchase part of a foreign firm (10% of more of the ordinary shares) e.g. BT buying a 15% share in a telecommunications company in Brazil

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What is meant by portfolio investments?

Portfolio investments are the same thing but where they buy less than 10% of the company

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What is meant by other investments?

Other investments include loans, purchasing of currency and bank deposits

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What does the balance of payments show?

The balance of payments shows all flows into and out of the country and since total inflows must equal total outflows, the balance of payments must balance. If there is a recorded deficit or surplus, this is a balancing item

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What is an instance where a country can have both a surplus and a deficit?

A country can run a deficit on the current account if they are able to have a surplus on the capital account

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What is a short term cause of a deficit or surplus?

High levels of consumer demand - if real household spending grows quicker than the supply side of the economy can deliver, the only way of meeting demand is by imports. High incomes in a country lead to high imports but have no effect on exports

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What is another short term cause of a deficit or a surplus?

Strong exchange rate - it reduces the UK price of imports and leads to a switch away from domestically produced goods. The high value of the pound improves the terms of trade between the UK and other countries, allowing us to buy more imports

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What is another short term cause of a deficit or a surplus?

A high level of relative inflation will decrease exports since it will increase their price compared to goods produced by other countries

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What is a medium term cause of a deficit or a surplus?

As a country loses its comparative advantage, people will transfer their purchases to other countries and the UK will need to switch resources to production of other things

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What is the UK's trade deficit due to?

Much of the UK’s trade deficit is due to structural rather than cyclical factors, due to supply side deficiencies

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What is a long term cause of a deficit or a surplus?

A lack of capital investment means firms use older and more out of date technology. This contributes to a lack of productivity

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What is another long term cause of a deficit or a surplus?

Deindustrialisation in the UK has led to a decrease in the relative importance of industry and manufacturing in the economy. This makes it more difficult to export, since services are harder to export

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What is another long term cause of a deficit or a surplus?

Countries with a large amount of natural resources tend to export more, and if they also have a small population then they tend to have a current account surplus e.g. Saudi Arabia

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What is one more long term cause of a deficit or a surplus?

Countries with corruption and where it is difficult to set up a business tend to find it difficult to export

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What are the two main causes of a deficit?

Demand side issues and supply side issues. This means there are two main ways to fix it: demand and supply side policies. Expenditure-switching policies can also be used

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What is a demand side policy that can be used to reduce imbalances?

Monetary or fiscal policy can be used to reduce AD. This reduces income so reduces demand for imports. It should be effective since there is high income elasticity for imports

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What is a supply side policy that can be used to reduce imbalances?

They could also use a range of measures to improve productivity and efficiency or improve quality. This could include competition policy, improving labour or improving infrastructure

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What is another supply side policy that can be used to reduce imbalances?

They can seek and encourage industries to exploit opportunities in export market overseas and focus resources on industries where the UK has a real comparative advantage. But this will cause job losses in the short term

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What is an expenditure-switching policy that can be used to reduce imbalances?

Tariffs or quotas will reduce the attractiveness of imports. However, they are likely to cause trade wars as other countries implement protectionist policies and so therefore may even worsen the deficit. These are almost impossible to implement

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What is another expenditure-switching policy that can be used to reduce imbalances?

They could attempt to control inflation which will mean that the price of British goods rises slower than those in other countries, meaning that they become more competitive over time. However, it will lead to a fall in demand for domestic goods

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What is another expenditure-switching policy that can be used to reduce imbalances?

They could also devalue/depreciate the pound as this will makes exports cheaper and imports dearer. However, this will not always work

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Why is depreciating the pound perhaps not a feasible solution?

It is not feasible for many countries as they have a floating exchange rate and so central banks intervening in the market will only nudge the exchange rate for a short period of time

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What is an argument made about the significance of a current account imbalance?

Some can argue that a current account imbalance is not much of a problem as long as the capital and financial account is in surplus

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What can be said about countries with large deficits?

Countries with large deficits are seen as having a problem, whilst those with large surpluses are seen as being successful but in reality, those with surplus cause just as much instability as those with deficits

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What does a current account surplus cause?

Current account surpluses cause losses for citizens in a country who don’t see the high living standards which they could enjoy from consuming more

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4.1.8

Exchange rates

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What is meant by an exchange rate?

The exchange rate is the purchasing power of a currency in terms of what it can buy of other currencies

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What is meant by a free floating system?

A free floating system is where the value of the currency is determined purely by market demand and supply of the currency, with no target set by the government and no official intervention in the currency markets

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What is meant by a managed floating exchange rate system?

Managed floating is where the value of the currency is determined by demand and supply but the Central Bank will try to prevent large changes in the exchange rate. This is done by buying and selling currency and by changing interest rates

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What is meant by a fixed system?

A fixed system is when a government sets their currency against another and that exchange rate does not change

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What is meant by an appreciation and a depreciation of the currency?

An appreciation of the currency is an increase in the value of the currency using floating exchange rates, whilst depreciation is a fall in the value of the currency under floating exchange rates

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What is meant by a revaluation and a devaluation of the currency?

A revaluation of the currency is when the currency is increased against the value of another under a fixed system, whilst devaluation of the currency is a decrease in the value of one currency against another under a fixed system

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What are floating exchange rates determined by?

Floating exchange rates are determined by the interaction of demand and supply and so are affected by changes in demand and supply

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What is the demand for pounds determined by?

The amount of British goods that foreigners want to buy; the number of foreigners wanting to invest in the UK, visit the UK or place their money in British banks; and the amount of speculation on the pound

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What is the supply of pounds determined by?

The amount of foreign goods people in the UK want; the number of British firms that want to invest abroad, the amount of British people wanting to go on holiday abroad or place their money in foreign banks; the amount of speculation on the pound

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In general, what is the currency affected by?

The currency is affected by the level of exports and imports , the level of investment, those going on holiday and speculation.

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What is most important determinant of the short-term price?

Speculation is the single most important determinant of the short-term price- if speculators fear a fall in the pound, the pound will fall as they will sell their pounds and buy another currency

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In the long term what is the currency determined by?

Exports, imports and long-term capital flows

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What is one form of government intervention that can be used to influence the value of their currency?

Interest rates - an increase in interest rates will strengthen the pound as people will convert their money to pounds to put them in English banks, so demand will rise. Falls in interest rates will decrease demand for the pound so weaken the currency

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What is another form of government intervention that can be used to influence the value of their currency?

Gold and foreign currency reserves - if the value of the pound is too high, they can increase supply by buying foreign currency or gold with pounds weakening it. To strengthen the pound, they can increase demand by selling their foreign currency

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What is meant by competitive devaluation/depreciation?

Where a country deliberately intervenes in foreign exchange markets to drive down the value of their currency to provide a competitive boost to their exporting industries

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How is a weaker currency beneficial to exporting industries?

A weaker currency will encourage exports and discourage imports and therefore the balance of payments should improve assuming the Marshall-Lerner condition

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What is perhaps a downside of competitive devaluation/depreciation?

The problem is that this can cause inflation and this may reduce competitiveness, leading to a fall in the balance of payments

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What is another downside of competitive devaluation/depreciation?

One problem is that other countries may follow and reduce their currency as well. This is unlikely if there is a current account deficit but if the country who devalues has a surplus, other countries are likely to retaliate

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What is the Marshall-Lerner condition?

The Marshall-Lerner condition states that the sum of the price elasticities of imports and exports must be more than one (i.e. elastic) if a currency devaluation is to have a positive impact on the trade balance

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What does the J-Curve show in terms of current account?

The J-curve shows how the current account will worsen before it improves in the short term. However, in the long term, the current account deficit will fall as demand becomes more elastic

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How does a change in the exchange rate impact economic growth and unemployment?

A weaker exchange rate is likely to increase exports, since they become cheaper, and decrease imports so lead to an increase in AD. This will increase employment and economic growth

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How does a change in the exchange rate impact the rate of inflation?

Falls in the exchange rate will increase inflation as imports become more expensive, causing a rise in prices and a fall in SRAS. Also, the net exports section of AD will increase and so inflation will rise further

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How does a change in the exchange rate impact FDI?

A fall in the currency may increase FDI because it becomes cheaper to invest. However, if the currency is continuing to fall then this is an indication that an economy has serious economic difficulties which will discourage investment

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4.1.9

International competitiveness

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What does a lower level of international competitiveness imply?

The lower the level of international competitiveness, the more likely that the country will face a current account deficit. For goods to be competitive internationally, they need to be cheap, have good quality and good marketing

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One measure of international competitiveness is relative unit labour costs, what is meant by this?

Unit labour costs are total wages divided by real output: the cost of employing workers for each unit of good. These are measured in an index number with one year chosen as a base year

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Another measure of international competitiveness is relative export prices, what is meant by this?

This is the price of UK exports compared to the exports of the UK’s main trading partners. A rise in relative export prices means UK export prices have risen more than other countries’ export prices and so the UK has become less competitive

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How do exchange rates influence international competitiveness?

A rise in the pound will cause exports to become more expensive, and thus make UK goods less competitive as their price changes. However, this depends on the elasticity the good and the reaction of the firms

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How does productivity influence international competitiveness?

A rise in productivity will cause a rise in the UK’s competitiveness because costs are lower and so prices will fall. Labour productivity is important

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How does regulation influence international competitiveness?

High levels of regulation slow down business decisions, making them less adaptable to changes in the global market. It also increases their cost of production. Therefore, regulation reduces competitiveness because of higher costs

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How does investment influence international competitiveness?

Investment in infrastructure improves productivity and ensures firms can deliver and produce their product efficiently. Investment in research and development allows firms to develop new products, which increases competitiveness compared to others

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How does taxation influence international competitiveness?

High levels of taxation reduce investment and so cause a reduction in international competitiveness in the long term. It can also reduce incentives for individuals to take risk, and thus reduce innovation

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How does inflation influence international competitiveness?

Low levels of inflation increase competitiveness since UK goods increase in price by less than goods in other countries and so they become more competitive over time

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How does economic stability influence international competitiveness?

If the country is not seen as stable, then there will be little long-term investment and so this will reduce competitiveness overtime

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How does flexibility influence international competitiveness?

If the labour market is flexible, this will improve competitiveness as businesses will be able to move labour in response to changes in demand and prevent unnecessary wage rises. This keeps costs and prices low

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How does competition and demand at home influence international competitiveness?

A good level of domestic demand will mean that firms in the country will already be producing in large numbers, experiencing economies of scale, and so have low AC curves

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How does the factors of production influence international competitiveness?

A country with a lot of good quality factors of production will be able to produce more and better quality goods than a country which has limited or poor quality resources

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How does the openness to trade influence international competitiveness?

This means trade barriers will be low and so other countries are likely to have low barriers on goods coming from the UK, meaning it is easier and cheaper to export. It also means that firms inside the UK will not suffer from high costs of production

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What is one benefit of competitiveness?

By being competitive, a country will experience current account surpluses . This surplus allows them the opportunity to invest overseas and build up a surplus of assets overseas, on which interest, profit and dividends can be earned

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What is another benefit of competitiveness?

A competitive economy is likely to attract inflows of foreign investment, whether this be by establishing new companies (creating jobs) or buying domestic firms. This will lead to a transfer of knowledge, skills and technology to firms

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What is another benefit of competitiveness?

Employment is likely to increase because more goods are being produced, since more goods are exported and less are imported, so more are sold internationally and domestically. A rise in demand for labour will lead to a rise in wages

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What is another benefit of competitiveness?

There will be economic growth, both by supply side improvements due to efficiency and investment and by demand side improvements relating to X-M

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What is a problem with competitiveness?

the problem with being internationally competitive is that this competitiveness can be easily lost

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What is another problem with competitiveness?

Countries who are competitive may become more dependent on overseas countries and so this may mean they suffer from larger issues if there is a global recession

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4.2

Poverty and Inequality

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4.2.1

Absolute and relative poverty

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What is absolute poverty?

Absolute poverty is when people are unable to afford sufficient necessities to maintain life. The UN defines absolute poverty as ‘a condition characterised by severe deprivation of basic human needs

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What is relative poverty?

Relative poverty is about people’s income compared to others in their area . Someone is said to be in relative poverty if their income falls below an average income threshold for the economy; they are at the bottom end of the income scale

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What is the poverty line?

The poverty line is the minimum level of income deemed necessary to achieve an adequate standard of living in a given country

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What is the poverty trap?

When the tax and benefits system creates a disincentive to look for work or work for longer hours. By working longer hours, individuals may find they lose income due to income tax and national insurance contributions

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What is the correlation between economic development and absolute poverty?

Economic development tends to be correlated with absolute poverty- the more developed a country, the fewer people in absolute poverty. In developed countries, the government tends to intervene to attempt to provide the necessities

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What is one cause of poverty?

Poverty is caused by unemployment, a lack of skills, health problems and income dependency

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What are the two main causes of relative poverty?

The two main causes of growth of relative poverty are if those on higher salaries see larger income growth than those on lower salaries or changes in government spending and taxation

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In the UK, what is one cause of the growth of relative poverty?

There has been growing inequality in wages growth , with the highest paid jobs seeing their wages increase higher than those on lower wages

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In the UK, what is another cause of the growth of relative poverty?

De-industrialisation has increased the number of service sector jobs which tend to be lower paid

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In the UK, what is another cause of the growth of relative poverty?

There has been a growth in underemployment, zero-hour contracts, part-time jobs and temporary jobs, all of which mean lower wages for workers

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In the UK, what is another cause of the growth of relative poverty?

The decline of trade unions has left many workers unable to bargain for higher wages

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In the UK, what is another cause of the growth of relative poverty?

State benefits have fallen in relative value whilst taxes have become more regressive and long term and structural unemployment has risen

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4.2.2

Inequality

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What is the difference between wealth and income?

Income is a flow of earnings, whilst wealth is a stock of asset

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What is income inequality?

Income inequality refers to the extent to which income is distributed in an uneven manner

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Why is wealth more unequally distribute than income?

Wealth is likely to be more unequally distributed than income because assets that make up wealth can be accumulated over time

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What is one measurement of income inequality?

The Lorenz Curve: This shows the cumulative percentage of the population plotted against the cumulative percentage of income that those people have

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On the Lorenz Curve how does the curve show income inequality?

A perfectly equal society would have a straight line from corner to corner; the degree of the bend away from that straight line indicates the degree of inequality

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What is another measurement of income inequality?

The Gini coefficient: the ratio of the area between the 45-degree line and the Lorenz curve divided by the whole triangle under the 45-degree curve. It is measured between 1 and 0 and the bigger the coefficient, the more unequal the country

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How do wages cause wealth and income inequality?

Some workers simply earn more than others. This can be because of higher educational achievements, because they work longer hours or because their skills are more in demand. Moreover, the higher the level of income, the more wealth can be built up

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How do wealth levels cause wealth and income inequality?

Someone who already has a high level of wealth, whether through inheritance or saving, is able to build up larger wealth than those on lower levels of wealth

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How does chance cause wealth and income inequality?

Those who bought houses in the right area or bought the right assets will see a huge increase in the price of their assets and hence an increase in their wealth. They may have been lucky to inherit wealth

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How does age cause wealth and income inequality?

Working adults at the peak of their career will earn a higher income than those who have just started. Those who are older will have had a chance to build up more assets, although some of this stock may have been used up to pay for retirement

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How is wealth and income inequality caused between countries?

Some countries have been held back by wars, droughts, famines and earthquakes. Certain social groups may have been excluded and marginalised. Developed countries tend to favour each other when trading, negotiating

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What does the Kuznets hypothesis say?

It says that as society develops and moves from agriculture to industry, inequality increases as the wages of industrial workers rises faster than farmers. Then, wealth is redistributed through taxation and government spending and so inequality falls

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How did Piketty counter Kuznets' hypothesis?

Piketty discredited this theory by arguing that inequality rises as the country develops as the rate of return on capital grows, so the rich get richer and inequality increases

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How does capitalism lead to income inequality?

A capitalist economy leads to income inequality because of wage differentials. Wages vary as they are based on demand and supply, and demand and supply vary for different jobs

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What is another way in which capitalism leads to wealth and income inequality?

Individuals also own resources and thus wealth differs based on the assets they own. Wealth can be passed on or gained through saving of incomes

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What is an argument that can be made about inequality and capitalism?

It is argued that equality can never be achieved in a capitalist society where the possibility of having more is important to encourage hard work; inequality is essential for capitalism to work

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4.3

Emerging and Developing Economies

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4.3.1

Measures of development

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What is economic development?

Economic development is about improvements in living standards

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HDI is a measure of economic development, but what is it based on?

It is a composite index based on health as measured by life expectancy at birth; o education as measured by the mean years of schooling of adults aged 25+ and income as measured by real GNI per capita at purchasing power parity

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What are advantages of HDI?

It is relatively easy to calculate; it takes into account three key factors which are important for the development of a country

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What are disadvantages of HDI?

Health takes no notice of the quality of life that people enjoy and education doesn’t take into account the quality and success of education; no consideration for the equality of income

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Another measure/indicator of economic development is the Inequality-adjusted Human Development Index, what is this?

This is an adjustment of HDI which includes a fourth indicator of development: inequality

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Another measure/indicator of economic development is the Multidimensional Poverty Index, what is this?

This measures the percentage of the population that is multidimensional poor . It uses data for health, education and standard of living but uses a broader range of indicators within these categories

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For MPI, what are does each category hold?

Years of schooling and school attendance data is used for education; child mortality and nutrition data for health; and availability of electricity, sanitation and safe drinking water in households, assets owned for standard of living

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Another measure/indicator of economic development is the Genuine Progress Indicator, what is this?

It is calculated from 26 different indicators grouped into three main categories: economic, environmental and social . It aims to look at economic sustainability, to ensure development does not limit the amount produced and consumed in the future

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In GPI what does the economic category hold?

The economic category looks at personal consumption, inequality and the cost of unemployment

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In GPI what does the environmental category hold?

Environmental accounts for the cost of pollution, loss of natural areas, CO 2 emissions, ozone depletion and the depletion of non-renewable resources

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In GPI what does the social category hold?

In social, the 10 indicators range from the value of housework and parenting to the cost of crime and commuting to the value of volunteer work

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4.3.2

Factors influencing growth and development

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What is one economic factor influencing growth and development?

Primary product dependency: primary products include agriculture, mining etc. A large amount of most developing country’s economic activity is based on a primary product. These cause issues for a number of reasons

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What is one problem with primary products?

Natural disasters can wipe out production of the primary product and so means that farmers are left with no income. They are often non-renewable, which means the country will suffer when they run out of the product

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What income elasticity do primary products tend to have?

They tend to have a low-income elasticity of demand , which means as people get wealthier, they don’t continue to increase the amount of primary products they buy whereas they are likely to increase their demand for manufactured goods

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What kind of supply and demand curves do primary products tend to have?

Primary products tend to have inelastic demand and supply curves which means relatively small changes in demand or supply leads to huge fluctuations in price

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What is another economic factor influencing growth and development?

Volatility of commodity prices: large changes in price mean that producers’ income and the country’s earnings are also rapidly fluctuating, making it difficult to plan and carry out long term investment and producers can see their income fall quickl

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What is another economic factor influencing growth and development?

Savings gap: Developing countries have lower incomes and thus they save less. This means there is less money for banks to lend, reducing borrowing and thus reducing investment/consumption

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What is a downside of the savings gap?

Economic growth is not the same as economic development. It is difficult for individuals to save when they have little income and borrowing from overseas causes problems with debt. It is possible that investment could be wasted

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What is a savings gap?

A savings gap is the difference between actual savings and the level of savings needed to achieve a higher growth rate

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What is another economic factor influencing growth and development?

Foreign currency gap: This is when exports from a developing country are too low compared to imports to finance the purchase of investment or other goods from overseas required for faster economic growth

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What is another economic factor influencing growth and development?

Capital flight:Large amounts of money are taken out of the country , rather than being left there for people to borrow and invest. If money was placed in banks within the country, then credit could be created by banks for consumers and businesses to

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What is another economic factor influencing growth and development?

Demographic factors: Developing countries tend to have higher population growth, which limits development. If population grows by 5%, the economy needs to grow by 5% to even maintain living standards

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What is another economic factor influencing growth and development?

Debt: Due to loan repayment and debt money is flowing from developing to developed countries meaning they have less money to spend on services for their population and they may need to raise taxes, which limits growth and development

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What is another economic factor influencing growth and development?

Access to credit and banking: Developing countries have limited access to credit and banking compared to developed countries, who have complex systems. This means those in developing countries cannot access funds for investment and struggle to save

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What is another economic factor influencing growth and development?

Infrastructure: Low levels of infrastructure make it hard for businesses to trade and set up within the country, for example if there are a lack of roads. It makes their services and production less reliable

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What is another economic factor influencing growth and development?

Education/skills: Poor education within these countries means that workers are low skilled, sometimes unable to read and write, so have low levels of productivity

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What is a downside of education/skills?

There is debate about what type of education is needed and problems concerning over-education i.e. if graduates are unable to find graduate level jobs

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What is another economic factor influencing growth and development?

Absence of property rights: A lack of rights mean that individuals and businesses c annot use the law to protect their assets, leading to reduced investment. They will be unwilling to buy machinery, build factories or establish brands

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What are property rights?

Property rights are where individuals are allowed to own and decide what happens to certain resources

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What is one non-economic factor influencing growth and development?

Corruption: Corruption means individuals will make decisions which maximise the bribes they receive as oppose to those which maximise development and output

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What is another non-economic factor influencing growth and development?

Diseases: Diseases such as HIV/AIDS and malaria have a negative impact on economic growth

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What is another non-economic factor influencing growth and development?

Poor climates and geographical terrain: Countries with poor climates and geographical terrain may suffer from natural disasters and it may be difficult for farmers or to set up businesses

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What is another non-economic factor influencing growth and development?

Civil wars: Civil wars causes high levels of poverty and destroys infrastructure, making it very difficult for the country to rebuild even after the war has ended

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4.3.3

Strategies influencing growth and development

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What is one market-orientated strategy influencing growth and development?

Trade liberalisation: Removing trade barriers will mean that domestic industries either close or are forced to become as efficient as other world producers. Resources will be allocated to their best use where the country has a comparative advantage

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What is another market-orientated strategy influencing growth and development?

Promotion of FDI: It will create jobs and leads to the effect of the multiplier. Labour productivity tends to increase and wages are often higher. It is a source of investment and can help to fill the savings gap

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What is FDI?

FDI is investment by one private sector company in one country into another private sector company in another

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What is a downside of the promotion of FDI?

There is usually a repatriation of profits and developing countries may find the company exploits them, by offering lower wages and poorer conditions than they would in a developed country and the country will lose sovereignty

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What is another market-orientated strategy influencing growth and development?

Removal of government subsidies: Subsidies to farmers and producers tend to lead to inefficiency and if they are given a large amount over a long period of time, the subsidy becomes ineffective in increasing development

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What is a downside of removing a subsidy?

Removing a subsidy can be politically unpopular and some governments have even been thrown out because of attempting to do this. The best time to remove a subsidy is when the free market price is falling, as this means the removal is less noticeable

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What is another market-orientated strategy influencing growth and development?

Floating exchange rate systems: In these systems, market forces determine the currency. The country does not have to worry about their gold and foreign currency reserves and the government does not intervene

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What is a downside of floating exchange rate systems?

It means that the currency can be volatile which makes it difficult for exporters/importers to make decisions about the future and can cause large changes in macroeconomic variables

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What is another market-orientated strategy influencing growth and development?

Microfinance schemes: These schemes aim to give poor and near-poor households permanent access to a range of financial services , including loans, savings, insurance and fund transfers

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What is a downside of microfinance schemes?

It has become a method of financing consumption spending and unemployment means that most people do not have the funds necessary to ensure repayment of their loan

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What is another market-orientated strategy influencing growth and development?

Privatisation: It can end the corruption within a firm who is owned by the state, as well as encouraging them to be more efficient by increasing competition. Selling off a firm, particularly if it is loss making, will improve government finances

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What is a downside of privatisation?

If the firm is privatised as a monopoly there will be no competition within the market. On top of this, it can be associated with corruption where politicians or officials sell the company at below market price to a friend or family member

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What is one interventionist strategy influencing growth and development?

Development of human capital: It provides workers with skills and thus help them to be more efficient. Higher skills would allow the country to develop from the primary sector to a manufacturing sector, overcoming primary product dependency

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What is another interventionist strategy influencing growth and development?

Protectionism: It allows domestic industries to grow by keeping foreign goods out and protects them from strong competition. This will create jobs in the short run and will allow the industry to develop, perhaps to the extent where the barriers go

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What is a downside of protectionism?

It means countries lose out from the benefits of specialisation and comparative advantage and could cause inefficiency, since domestic producers suffer from a lack of competition

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What is another interventionist strategy influencing growth and development?

Managed exchange rates: The currency could be fixed against a number of different exchange rates

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When can a high exchange rate be used?

A high exchange rate for essential products will mean that the price within the country is low, which helps to reduce poverty if the goods are consumer goods and encourages investment if they are capital goods

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When can a low exchange rate be used?

A lower exchange rate for other imports will mean that the price of these goods within the country is higher, discouraging their import and encouraging consumers to buy from domestic producers

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What is a downside of managed exchange rates?

The problem with these tiered exchange rates is that they often fail to work in practice; black markets in foreign exchange develop which can destabilise the system and corruption becomes an issue

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What is another interventionist strategy influencing growth and development?

Infrastructure development: Infrastructure is essential for development ; a country needs roads, airports, schools, hospitals, railways etc

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What do interventionists argue in stark contrast to a market-based system?

Interventionists believe the government should provide these systems whilst a market-based system would be for the private sector to provide them

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What is a positive of infrastructure development?

It has many positive social benefits which suggests the government should provide it

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What is a downside of infrastructure development?

The government may not have the funds to provide the infrastructure and it is argued that they may be inefficient. Also, it tends to suffer from the free rider problem and has very high capital costs , meaning the private sector will not develop it

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What is another interventionist strategy influencing growth and development?

Promoting joint ventures with global companies: The government may insist that firms setting up production plants in their country find a local partner to create a jointly owned company with

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What is a positive of promoting joint ventures with global companies?

This will help to keep some of the profits generated within the country, which can be used in investment. Also it will help to reduce the exploitation of countries as a result of FDI would be to set up a joint venture

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What is another interventionist strategy influencing growth and development?

Buffer stock schemes: This is where the government imposes both a maximum and minimum price for goods, buying up stocks when there is excess supply and selling them off when there is excess demand

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What is a positive of buffer stock schemes?

It should be self-financing: money is raised when selling the products, which allows the government to buy the next lot of stocks. Also,

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How beneficial are buffer stock schemes when used on commodities?

It is used on commodities, where the prices are volatile, and can either be set up by a group of countries or within a country. When it works effectively, it is beneficial because it stabilises prices and thus encourages investment

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What is a downside of buffer stock schemes?

It requires stocks to go up and down ; if they keep rising, then the scheme will run out of money and if they keep falling, the scheme will run out of stocks and they require huge start-up costs

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What is one other strategy influencing growth and development?

Industrialisation: According to the Lewis model he believed savings and investment were the key to growth and thus growth could be achieved through rural-to-urban migration

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What is the Lewis model?

The Lewis model assumed that developing countries had dual economies with a traditional agricultural sector, which had low wages, low productivity, underemployment and a modern industrial sector, with high levels of investment and urbanisation

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What is a downside of industrialisation?

Although labour productivity is low for some parts of the year, during planting and harvesting vast amounts of labour is needed. Also, it is not necessarily true that those with higher wages will save and invest their money

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What is another other strategy influencing growth and development?

Development of tourism: Some countries have decided to take advantage of their climate and geography to build up a tourism industry. This provides them with the funds to develop their economy and improve living standards

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What does the income elasticity of tourism suggest?

The income elastic nature of tourism means that as the global economy grows, demand for the industry will increase even further, allowing the developing country to continue development

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What is a downside of the development of tourism?

the industry is seasonal and involves low skilled, low paid jobs which means the effect of the multiplier is limited. Tourism destinations can go in and out of fashion, meaning some areas will see a loss of employment

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What is another other strategy influencing growth and development?

Development of primary industries: The development of a primary industry provides funds to allow a country to diversify as well as allowing infrastructure development and better education

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What is a downside of the development of primary industries?

Primary products are volatile and primary product dependency causes many issues. Primary industries also suffer from corruption

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What is another other strategy influencing growth and development?

Fairtrade schemes: A fair price typically means that agreements are made to buy a guaranteed amount of produce over a period of time at a price which is above the market price when the agreement was made. This gives producers stability and raises the

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What is a downside of fairtrade schemes?

d. It benefits the Fairtrade producers but can leave others worse off since non-Fairtrade producers see a fall in demand

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What is another other strategy influencing growth and development?

Aid: This is when a country voluntarily transfers resources to another or gives loans on concessionary terms

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What is tied aid?

Tied aid is aid with conditions attached, such as economic or political reforms or a commitment to buy goods from the donor country

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What is bilateral aid?

Bilateral aid is directly from one country to another

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What is multilateral aid?

Multilateral aid is when countries give aid to an international organisation who distributes it to other countries

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What are concessional loans?

Concessional loans are loans given on lower, or no, interest rates

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What are the positives of aid?

It is good as it is able to reduce absolute poverty; it can fill the savings gap; it also provides foreign exchange to fill the foreign currency gap; it can contribute to increased globalisation and trade as well as reducing world inequality

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What is a downside of aid?

Some argue it results in a dependency culture where countries are unconcerned by their finances as they know they can receive aid from another country

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What is another other strategy influencing growth and development?

Debt relief: Many countries suffer greatly from the high interest repayments to loans they have taken out. It limits the growth of some of the poorest countries, whilst being relatively small for the countries and agencies that are owed the money

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What is a positive of debt relief?

It will ease government finances and allow more money to be spent on provision of services and infrastructure to aid development

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What is a downside of debt relief?

It causes moral hazard because it creates a precedent: every poor country may now expect to receive debt relief. It also eases pressure on weak governments to adopt reforms and good economic policies

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What is the World Bank?

The World Bank was founded at the Bretton Woods Conference after the Second World War. It aims to bring about long-term development and a reduction in poverty

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What is the World Bank made up of?

The International Bank for Reconstruction and Development (IBRD); The International Development Association (IDA); The International Finance Corporation (IFC); The Multilateral Investment Guarantee Agency (MIGA); (ICSID)

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What does the IBRD and IDA do?

The IBRD and IDA provide financing, policy advice and technical assistance : IDA helps the poorest countries whilst IBRD helps middle income and creditworthy poorer countries

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What does the IFC, MIGA and ICSID do?

IFC, MIGA and ICSID help strengthen the private sector in developing countries by providing them with finance, technical assistance, political risk insurance and settlement of disputes

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What is the International Monetary Fund (IMF)?

They provide loans to help countries when there are international exchange rate crises or when they cannot afford to pay off their international debt

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What is a downside of the IMF?

Countries are not forced to turn to the IMF for help but many do because the alternative is defaulting on their loans , which would cause even more problems than the reforms do

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What is are NGOs?

These are non-profit organisations that are run independently from the government

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What is a downside of NGOs?

A problem of NGOs is that it is believed that they alone can never solve the problem, it is the government who has to fix the issues

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4.4

The Financial Sector

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4.4.1

Role of financial markets

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What are financial markets?

Financial markets are where buyers and sellers can buy and trade a range of services or assets that are fundamentally monetary in nature

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What are two reasons financial markets exist for?

To meet the demand for services , such as saving and borrowing, from individuals, businesses and the government and to allow speculation and financial gains

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What is one role of the financial market?

To facilitate savings, which allows people to transfer their spending power from the present to the future. It can be done through a range of assets, such as storing money in savings account and holding stocks and shares

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What is second role of the financial market?

they lend to businesses and individuals which allows consumption and investment. They are sometimes referred to as a financial intermediary, the step between taking money from one person to give to another

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What is third role of the financial market?

They facilitate the exchange of goods and service s by creating a payment system. Central banks print paper money, institutions process cheque transactions, companies offer credit card services and banks buy and sell foreign currencies

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What is a fourth role of the financial market?

They provide forward markets . This is where firms are able to buy and sell in the future at a set price

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What is a fifth role of the financial market?

They provide a market for equities , company’s shares. Issuing shares is an important way for companies to finance expansion but people would be unlikely to buy shares if they were unable to sell them on in the future

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4.4.2

Market failure in the financial sector

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Why are financial markets prone to regular crises?

The combination of speculation and provision of genuine services means that financial markets are prone to regular crises that cause significant damage to the real economy

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What is one problem with the financial sector?

Asymmetric information: Financial institutions have more knowledge compared to their customers and other institutions. This means they can sell them products that they do not need, are cheaper elsewhere or are riskier than the buyer realises

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What is a second problem with the financial sector?

Externalities: There are a number of costs placed on firms, individuals and the government that the financial market does not pay

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What is a third problem with the financial sector?

Moral hazard: This is where individuals make decisions in their own best interests knowing there are potential risks. it will occur where individual workers take adverse risk in order to increase their salary

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What is a fourth problem with the financial sector?

Speculation and market bubbles: Almost all trading in financial markets is speculative and this leads to the creation of market bubbles, where the price of a particular assets rises massively and then falls

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How do market bubbles work?

Investors see the price of an asset rising and so decide to purchase the asset for profit. This leads to prices becoming excessively high and eventually enough investors decide that the price will fall, so they sell their assets causing mass selling

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What is fifth problem with the financial sector?

Market rigging: This is where a group of individuals or institutions collude to fix prices or exchange information that will lead to gains for themselves at the expense of other participants in the market

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4.4.3

Role of central banks

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What is the role of the central bank?

The central bank controls monetary policy through interest rates and controlling money supply in order to keep inflation low and stable

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What is another role of the central bank?

It acts as a banker to the government. The exact nature of the services offered by the bank differs from country to country

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What is another role of the central bank?

They act as a bank to other banks . Banks deposit their money within the central bank and this is often used to balance the accounts of banks at the end of each day, when banks owe each other money because cheques have been paid in by consumers etc

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What is a fourth role of the central bank?

Central banks in some countries regulate the financial system . This is important to prevent financial institutions from undertaking activities which harm consumers or engage in risky activities which would lead to collapse

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What are examples of financial regulation?

banning market rigging; preventing the sale of unsuitable products; maximum interest rates to prevent consumer exploitation and prevent excessively risky lending; deposit insurance to protect consumer deposits and increase stability; liquidity ratios

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What are the three key bodies for financial regulation?

The FPC; the PRA; the FCA

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What does the FPC do?

The FPC identifies and reduces system risk and supports government economic policy (macroprudential)

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What does the PRA do?

The PRA ensures competition, ensures consumers have access to services, minimises risk should a bank fail and ensures banks take responsible action. (microprudential)

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What does the FCA do?

The FCA protects consumers, promotes competition and enhances the integrity of the system by preventing market rigging

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4.5

Role of the State in the Macroeconomy

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4.5.1

Public expenditure

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What is capital government expenditure?

Capital government expenditure is spending on investment goods such as new roads, schools and hospitals which will be consumed in over a year

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What is general government final consumption?

General government final consumption is spending on goods and services that will be consumed within the next year, such as public-sector salaries

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What is transfer payments?

Transfer payments are government payments for which there is no corresponding output, where money is taken from one group and given to another, for example benefits and pensions

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What is current government expenditure?

The current government expenditure is general government final consumption plus transfer payments plus interest payments

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What is the general relationship between average income and the percentage of GDP spent in most mixed and free economies?

In most mixed and free economies, the lower the average income of the country, the lower is likely to be the percentage of GDP spent by the government

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Why is this the relationship in most free and mixed economies?

This is because poorer countries tend to have a lower tax revenue , due to avoidance, inefficiency at collecting and a smaller amount of wealth to tax

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What did the global financial crisis lead to with respect to government spending?

The Global Financial Crisis led to huge increases in government spending as governments had to increase welfare payments and some governments used taxpayer money to bail out the banks

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What do free market economists argue about government spending?

Free market economists argue that government spending is wasteful and causes inefficiency

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What is one impact of government spending with regards to productivity and growth?

The government is able to enjoy economies of scale when it provides goods, and this improves productivity

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What is another impact of government spending with regards to productivity and growth?

Education creates the human capital necessary for growth whilst the healthcare system reduces the number of days workers lose from serious illness

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What is another impact of government spending with regards to productivity and growth?

Through spending, the government can create a multiplier effect and this can be focused on areas of the country with high unemployment, creating growth

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What is one impact of government spending with regards to living standards?

Government spending can cause large improvements in living standards. The government corrects market failure and provides public goods , which improves social welfare

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What is another impact of government spending with regards to living standards?

They are also important since they reduce absolute poverty by providing benefits and basic goods, such as education and healthcare. In developing countries, governments do not have the resources to do this and this leads to malnutrition

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What is an argument that can be made suggesting that government spending does not have an impact on living standards?

It is argued that the government will be inefficient at providing goods and services and will have a negative disincentive impact on workers, meaning that output overall is reduced and so living standards fall

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What is another argument that can be made suggesting that government spending does not have an impact on living standards?

It can be argued that the government suffers from the principal agent problem as they make decisions on behalf of the people and individuals may have spent that money differently. As a result, there is a loss in welfare and a fall in living standard

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What is one impact of government spending with regards to crowding out?

In order to spend money above their tax revenues, the government has to borrow from individuals and businesse s. However, the amount of money in the economy available to borrow does not increase

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What is the result of the government borrowing from individuals and businesses?

The government will therefore be competing with the private sector for finance and will cause higher interest rates . This will discourage firms from investing and individuals from buying on credit

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How does government borrowing affect the private sector?

On top of this, the limited number of resources in the economy means that for every resource used in government spending, there are less resources available for the private sector

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How does government borrowing cause 'crowding out'?

The result is that government borrowing crowds out private sector borrowing and spending and may lead to no real increase in AD

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What do free market economists argue with regards to investment?

Free market economists argue that investment would be more efficient if done by the private sector and that the government targets investment poorly and is wasteful

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At what level of employment is the crowding out effect felt the most?

At full employment, but it is not always the case. In other cases, when levels of unemployment are high then extra government spending could lead to crowding in where it encourages investment through the multiplier

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What is one impact of government spending with on the level of taxation?

In most cases, where government spending is high, levels of tax must be high in order for spending to be sustainable. High levels of tax may have a disincentive effec

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In what countries is the above impact an exception?

Oil-rich countries tend to be an exception, where revenue from oil can pay for most of government spending

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What is one impact of government spending on equality?

Spending should increase equality as it leads to redistribution and helps to provide a minimum standard of living for the poorest in society. It ensures everyone has access to basic goods, such as education and healthcare

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4.5.2

Taxation

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What is tax used for?

Tax is used to pay for the number of goods and services that the government provides . On top of this, tax can be used to correct market failure at a microeconomic level and to manage the economy and redistribute income at a macroeconomic one

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What is a progressive tax?

Progressive tax is where those who are on higher incomes pay a higher marginal rate of tax; they pay a higher percentage of their income on tax

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What is an example of a progressive tax?

Direct taxes tend to be progressive, for example income tax

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What is a regressive tax?

Regressive tax is where the proportion of income paid in tax falls as the income of the taxpayer rises. Those on higher incomes pay a smaller percentage of their income on the tax

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What is an example of regressive tax?

Most indirect taxes are regressive, for example everyone pays the same rate of VAT and for those on higher wages this represents a small proportion of their earnings compared to those on low wages

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What is a proportional tax?

Proportional tax is where the proportion of income paid on tax remains the same whilst the income of the taxpayer changes e.g. 10% of income is spent on tax, regardless of income

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What are some of the impacts of tax changes on incentives to work?

It is argued that high marginal rates of tax will discourage individuals from working. High taxes on high income earners could encourage them to move abroad and taxes on the poor may lead to a poverty trap

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What do free market economists argue about the supply of labour?

Free market economists argue that the supply of labour is relatively elastic and a reduction in marginal taxes on income will lead to a significant increase in work as individuals work longer hours, accept promotions and more people join workforce

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Which type of tax is more important with regards to incentives, VAT or income tax?

It is income tax which is important: high income tax reduces incentives more than high VAT. Thus, a switch from direct to indirect taxes may increase incentives

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What is a common argument that can be made regarding higher taxes?

It can be argued that higher taxes mean people have to work longer hours in order to maintain their income and so even increases the incentive work

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What does the Laffer curve show regarding tax revenue after a tax change?

The Laffer curve shows that a rise in the tax rate does not necessarily increase tax revenue. If people were taxed at 100%, they would not do any work and this means that tax revenue is 0 at both 0% and 100%

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What can be inferred by the shape of the Laffer curve?

Tax revenue will initially rise as the tax rate is increased but it will come to a point where revenue is maximised and will then fall. As tax rates rise, motivation and drive will fall so there will be a fall in output

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What is a likely consequence following an increase in tax rates?

There is an increased incentive to use tax avoidance and tax evasion

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Why can revenue from indirect taxes be uncertain?

Revenue from indirect taxes can be uncertain as they depend on consumer spending patterns

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What is the impact of tax changes on income distribution?

A progressive tax system will increase the equality of income distribution as more money is proportionally taken from the rich than from the poor. A regressive one will decrease income equality

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Does a change from indirect to direct taxes, or direct to indirect taxes improve inequality?

Since direct taxes tend to be progressive and indirect taxes regressive, a move from indirect to direct taxes will improve equality

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What is a problem with using tax to redistribute income?

One problem with using tax to redistribute income is that it does not give the poor anything, so the system needs to be supported with benefits

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What is one impact of tax changes on real output and employment?

A rise in direct taxes will reduce the level of disposable income an individual has, which will cause a fall in their spending and thus a fall in AD

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What is another impact of tax changes on real output and employment?

s, higher indirect taxes and NICs increase costs for firms and this will decrease SRAS. This impact will again depend on where the economy is producing

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How do income tax changes affect LRAS?

it can be argued that income taxes cause a disincentive to work and therefore reduce LRAS as the most skilled workers go overseas and more people become inactive

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What is the impact of tax changes on the price level?

As explained above, taxes can impact LRAS, SRAS and AD. Therefore, these changes will impact price depending on where the economy is producing. Indirect taxes, particularly VAT, often cause cost push inflation

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What is one impact of tax changes on the trade balance?

A rise in taxes will decrease income and therefore decrease consumption, theoretically this will also mean consumers spend less on imports

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What income elasticity are imports in the UK?

Imports in the UK have been found to be highly income elastic. As a result, the trade balance will improve in the short run

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What is the impact of tax changes on the trade balance in the long run?

In the long run, lower AD will reduce businesses’ need to invest and this could reduce competitiveness meaning that exports decrease

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What is one impact of tax changes on FDI flows?

Low taxes on profit and investment tend to encourage businesses to invest in a country since it will help them to see a higher level of return

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What is the problem with lower taxes?

The problem with this is that it can be a ‘race to the bottom’ where countries have to continue to lower their taxes in order to make them the lowest to encourage investment; the eventual result is a fall in revenues for all countries

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4.5.3

Public sector finances

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What is the problem with lower taxes?

The problem with this is that it can be a ‘race to the bottom’ where countries have to continue to lower their taxes in order to make them the lowest to encourage investment; the eventual result is a fall in revenues for all countries

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4.5.3

Public sector finances

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What are automatic stabilisers?

Automatic stabilisers are mechanisms which reduce the impact of changes in the economy on national income; government spending and taxation are automatic stabilisers

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How are automatic stabilisers used in a recession?

n a recession, benefits increase as more people are unemployed and so the benefits are a stabiliser as it means that the overall fall in AD is reduced, preventing too much change in the economy

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How are automatic stabilisers used in a boom?

during a boom, tax increases as people have more jobs and higher incomes, and this tax reduces disposable income so decreases consumption and AD, meaning that demand doesn’t grow too high

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Do automatic stabilisers prevent fluctuations?

These automatic stabilisers cannot prevent fluctuations; they simply reduce the size of these problems and there can be negative aspects to these stabilisers

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What is a problem with automatic stabilisers?

Benefits may act as a disincentive to work and lead to higher unemployment whilst high levels of tax can decrease the incentive to work hard

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What is discretionary fiscal policy?

Discretionary fiscal policy is the deliberate manipulation of government expenditure and taxes to influence the economy; expansionary and deflationary policies

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What is national debt?

The national debt is the sum of all government debts built up over many years

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What is fiscal deficit?

A fiscal deficit is when the government spends more than it receives that year

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What is a cyclical deficit?

A cyclical deficit is the part of the deficit that occurs because government spending and tax fluctuates around the trade cycle. When the economy is in recession, tax revenues are low and spending is high creating a larger deficit

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During the peak of a boom is it a structural or cyclical deficit?

At the peak of the boom, there is no cyclical deficit; any deficit at this point is a structural deficit

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What is a structural deficit?

The structural deficit is the fiscal deficit which occurs when the cyclical deficit is zero; it is long term and not related to the state of the economy

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What is the actual deficit?

The actual deficit is the structural deficit plus the fiscal deficit

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When does a structural surplus occur?

A structural surplus occurs when at the peak of the boom, there is an actual fiscal surplus whilst a structural balance occurs when at the peak of the boom, the actual fiscal balance is 0

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What is the correlation between structural deficits and national debt?

If the government has a structural deficit, it is likely that national debt will grow over time as the government has to consistently borrow money to finance spending

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Why is it difficult to eliminate structural deficits?

It is argued that structural deficits need to be eliminated but this is difficult since it is impossible to know what part of the deficit is structural and what part of it is cyclical

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What is one factor influencing the size of fiscal deficits?

One big factor which influences the fiscal deficit is the trade cycle, as explained by the concept of cyclical and structural debts. During a downturn, government tax revenue decreases whilst government spending increases and so the deficit increases

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What is another factor influencing the size of fiscal deficits?

Interest rates play a role. If interest rates on government debt increase, the amount the government pays in interest repayments increases and this is likely to increase the deficit

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What is another factor influencing the size of fiscal deficits?

Events like privatisation provide one-off payments to the government which will decrease the deficit in the short term; it will depend on the value of the company sold

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What is another factor influencing the size of fiscal deficits?

Unforeseen events, such as natural disasters or recessions, lead to huge increases in spending which increase the deficit

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What is another factor influencing the size of fiscal deficits?

Government aims are important in the size of the deficit, as this will influence their fiscal policy, for example the austerity aim has helped to decrease the size of the deficit but attempting to increase AD would increase spending

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What is another factor influencing the size of fiscal deficits?

Many countries with high revenues from oil, for example the OPEC countries, run a budget surplus and so government revenue is important in the size of the deficit also the number of dependent in a country affect both spending and tax revenues

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What is a factor influencing the size of national debts?

If the government is continuously running a deficit, then the national debt will increase overtime. There is a consensus view that fiscal deficits over 3% will lead to growing national debt as a proportion of GDP

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What is another factor influencing the size of national debts?

Ageing populations tend to contribute to a high national debt since the government runs a structural deficit in order to fund their pensions and care and this leads to a high national debt

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What is the impact of high levels of borrowing?

High levels of borrowing may raise interest rates in the economy since an increase in the demand for money will increase the price of money, i.e. interest rates. This could cause crowding out of the economy

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Why may high levels of borrowing not always raise interest rates?

This may not always be the case as the government may borrow from overseas and during a recession, private sector investment falls which means interest rates may remain unchanged

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What do some economists argue about deficits being beneficial?

Some economists argue that high fiscal deficits and national debts benefit citizens today at the expense of future generations and can cause intergenerational inequality

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What is a current budget deficit?

A current budget deficit is one where government revenues are less than current expenditure

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Why may a current budget deficit be problematic?

A current budget deficit is problematic as it means that future generations are forced to pay the bill for today’s expenditure

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Why is a deficit due to capital expenditure beneficial?

If the deficit is due to capital expenditure, the future generations benefit from increased spending and so their extra tax bill to pay for today’s borrowing can be justified

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How do fiscal deficits affect inflation?

High fiscal deficits can cause inflation. If the government increases their spending and there is no similar fall in private sector spending, AD will rise and this can be inflationary

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How does the level of debt affect credit ratings?

High levels of debt tend to result in a reduced credit rating for the government. Private sector companies estimate the likelihood that a government will default on its debt and give it a rating from AAA to D

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How can credit ratings be interpreted?

Lower credit ratings mean that lending to the government is riskier and so higher interest rates are demanded from lenders

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What influences the level of risk involved with lending money to a government?

In reality, it is not the size of the debt that influences the level of risk involved with the lending the money, it is whether that country has ever defaulted on their loans before and their current economic/political climate

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What is a problem associated with governments borrowing from abroad?

If a government borrows from abroad, it may have difficulties getting enough foreign currency to make repayments on its debt. This could also cause problems for consumers as if there is not enough foreign currency, they will be unable to import goods

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Why can government borrowing benefit growth?

government borrowing can benefit growth if it used for capital spending since this will improve the supply side of the economy and thus reduce the deficit in the long term

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What do Keynesians argue regarding budget deficits and their use?

Keynesians argue a deficit is acceptable to use as a stimulus in demand during recessions

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4.5.4

Macroeconomic policies in a global context

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Generally, what are all the strategies the government can use to achieve a number of goals?

Fiscal policy, monetary policy, supply side policy, exchange rate policy and direct controls

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What are examples of direct controls?

Direct controls include minimum or maximum prices/wages, quotas on imports, limits on currency or regulation e.g. maximum interest rates

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What did the UK do in 2010 to decrease national debt?

To decrease the national debt, the UK government has been using a policy of austerity since 2010, where they attempt to decrease spending. It would also be possible to increase taxes

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What is an alternative method to decrease national debt?

Opposition parties offer an alternative in the form of demand stimulus by high spending , which will cause economic growth and therefore bring about higher tax revenues allowing for budget surpluses reducing national debt

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What is another method to decrease national debt?

Another approach is to simply rely on automatic stabilisers to allow the economy to grow so national debt/fiscal deficit will reduce as a percentage of GDP. This is mainly the approach that the US took after the Global Financial Crisis

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What is a final way to decrease national debt?

One way to reduce national debt would be for the government to default on their loans but the economic cost of this is so large that governments only default if it is the only option

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What is one method to reduce poverty and inequality?

The government can use a progressive tax system which will produce a more equal distribution of income after tax. Inheritance taxes mean that wealth inequality will be reduced as less money can be passed on to the next generation

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Why may a progressive tax system not be effective?

This tax is difficult to enforce as they are avoidable by careful tax planning

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What is another method to reduce poverty and inequality?

They can use government expenditure in the form of benefits and transfer payments. Social security and National Insurance benefits now represent 30% of government spending in the UK

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What are universal benefits?

Universal benefits are available to everyone who meet certain criteria, respective of personal income e.g. winter fuel allowance, child benefits

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What are means tested benefits?

Means tested benefits are only available to people who have sufficiently low levels of income/wealth. They are targeted at people who need the most help and provide a safety net/minimum standard of living

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Why are means tested benefits fairly effective at improving inequality?

They are better at improving inequality since they directly affect the poor

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What is an argument against the use of benefits?

Some argue that benefits reduce people’s incentive to work, especially if they can earn a similar amount on benefits to what they could in work

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What is another method to reduce poverty and inequality?

The government can also provide goods and services which give citizens equal opportunities and access to services they may not otherwise be able to afford, such as healthcare, education and housing

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What is another method to reduce poverty and inequality?

The government can attempt to reduce wage differentials through a national minimum wage; equal pay legislation and trade union friendly legislation

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What is another method to reduce poverty and inequality?

They could introduce price controls on essential goods, such as housing, bus fares, bread, electricity etc

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What would be a free market approach to reducing poverty and inequality?

Free market economists use the concept of trickle down, arguing that increasing the incomes of the rich will lead to an increase in the income of the poor. The rich create jobs by spending their money and employing others

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What does the central bank do?

The central bank has the ability to change interest rates and monetary supply. They may do this for domestic reasons, such as to control inflation, or due to global issues such as a low exchange rate or a change in world commodity prices

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What would a fall in the bank rate mean for the money supply?

A fall in the bank rate is likely to increase the supply of money because it will mean there is more demand for loans

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What is the relationship between the supply of money and inflation?

There is no simple relationship between the supply of money and inflation and it can be argued that central banks don’t have complete control over the money supply because they cannot control the ability of the financial system to create credit

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What is the consensus that central banks should follow regarding inflation?

The consensus is that central banks should allow inflation caused by supply side shocks but manage demand side inflation

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Generally, what can the government do to improve international competitiveness?

The government can improve competitiveness by taking action to increase any of the factors which affect competitiveness

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What is one method that can be used to improve international competitiveness?

Supply side measures will improve productivity and flexibility and can involve taxes and deregulation. They can encourage competition, forcing firms to be efficient and thus competitive within the global market

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What are other methods that can be used to improve international competitiveness?

Exchange rate policies may be used, and they may control inflation and macroeconomic stability or they can join the WTO or sign trade agreements

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What has globalisation led to in terms of dependency between economies?

Due to globalisation, the world’s economies are increasingly interdependent

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What is one example of a government dealing with external shocks?

One example could be a commodity price shock , for example where oil prices greatly increase. The government could use expansionary policy to reduce the impact of a fall in GDP or they could use deflationary policy to reduce the impact on inflation

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What is another example of government managing external shocks?

Another example may be a financial crisis, where the government can use expansionary policy to increase AD

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Following the financial crisis how much of the UK weakness in output was due to shocks in the global economy?

It is estimated that shocks in the global economy accounted for about 2/3 of weakness in the UK output after the financial crisis, due to the impact on trade

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What actions did the UK take following Brexit?

Following Brexit, interest rates were lowered to improve confidence but then raised to deal with inflation caused by the falling value of the pound

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What is the benefit of transnational companies?

TNCs can bring huge gains to an economy through their creation of jobs, the tax revenue they raise, the knowledge they bring and the investment they undertake

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What is a downside of TNCs?

They can have a negative economic and social impact by destroying local culture, the environment and withdrawing more in profits than they inject through investment. They also have a history of influencing politicians to take decisions that help them

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What have the USA and UK done to deal with TNCs?

In the EU and the USA, it is illegal for TNCs operating in their country to use bribery or corrupt practices anywhere in the world and they can be fined for doing so

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What do some developing countries do to deal with TNCs?

Some developing countries don’t allow TNCs to set up in their country without first setting up a joint company with a local partner, meaning that some profits are retained within the country and knowledge/technology is transferred

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What is one more way government deal with TNCs?

Many governments use import contracts with TNCs, meaning that at least some part of the value of the order must be manufactured in the country

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What is transfer pricing?

Transfer pricing is one way for firms to engage in tax avoidance. This can occur if a firm produces a good in one country and then transfers it to another to make it into another good which it then sells

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What is the aim with transfer pricing?

The overall aim is to increase their profit made in the low tax country and decrease it in the high tax country and so overall reduce their tax bill

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What do the UK do to deal with transfer pricing?

In the UK, companies which don’t allocate sufficient profits here are challenged by HMRC and this has led to billions of pounds earned in taxes

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What was introduced in 1995 to deal with transfer pricing?

The Transfer Pricing Guidelines were introduced by the OECD in 1995, providing guidelines on cross-border services, intangibles, cost contribution arrangements and advance pricing guidelines; these were modified in 2010

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How easy is it for individual governments to control TNCs?

It is difficult for individual governments to control TNCs. Small countries may earn less in revenue than a TNC earns in profits

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What is the legal tax avoidance scheme that the EU suffers from?

The EU suffer from the ‘Dutch sandwich’ and the ‘double Irish’, where costs, revenues and profits are routed through Ireland, the Netherlands or Luxemburg and then sent to a tax haven like the Bahamas or the Cayman Islands

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Why are solutions to taxation difficult?

Solutions to taxation are extremely difficult as they require worldwide agreement. However, any solution which would benefit a country like the UK would lead to great losses for countries like the Bahamas, Ireland and Luxembourg

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What is one problem policy makers face?

Inaccurate information: Short term information, such as GDP figures for the previous month, are often inaccurate and so may mean that the government is unable to see if there are problems within the economy

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What is a second problem policy makers face?

Risks and uncertainties: The government cannot accurately predict the future and so it is difficult for them to know whether extra spending is necessary etc

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What is a third problem policy makers face?

External shocks: The government is unable to control and prepare for these external shocks; the best they can hope to do is lessen their impact

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MACRO DONE

GOOD LUCK!

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Economics (Macro)

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