What is the economic problem?
Scarce resources but unlimited wants and needs
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How do we assess economic performance?
• Output • International trade position • Unemployment • Inflation
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What is output?
Productivity/activity (goods and services)of a country (economic growth)
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What is international trade position?
Balance of payments (level of inputs and outputs)
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What is inflation?
sustained increase in price level or cost of living leading to a fall in purchasing power
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What is meant by Real GDP?
Total output of an economy (indicates standards of living and level of employment) at a given time
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Spending on household goods and services by the general public
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What are the effects of a fall in consumption?
Jobs are lost Less imports or exports Decrease in government income (tax)
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What is disposable income?
Income - income tax + state benefit received
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What is discretionary income?
Disposable income – necessary payments (e.g. mortgages)
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what factors effect consumption?
interest rates, access to credit, house sales, price of assets
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How does an increase in interest rates effect consumption?
• Increase in price of credit so there is less borrowing and consumption • More money spent on mortgages and necessary payments so a decrease of discretionary income and there for a decrease in consumption
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How do house sales effect consumption?
More consumption of related services (such as estate agents) and household goods
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How does the price of assets such as house prices effect consumption?
People feel more financially secure as they feel the value has increased and so are more willing to consume
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What factors influence consumption?
• Access to credit • Interest rates • House sales • Price of assets (e.g. shares and wealth)
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Spending by governments or businesses on capital goods
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What are the short term effects of investment?
Influences immediate demand for related goods which and services that produce the capital goods
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What are the long term effects of investment?
Investment in some goods will increase productive capacity of others increasing PPF of economy
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What influences investment?
• Interest rates • Risk and uncertainty (due to fluctuating market or week government policies) • Tax • Business prediction
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How do interest rates effect investment?
Higher interest rate means higher cost of funds means lower profit so possibly less willing to invest
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How does tax influence investment?
Profit is a source of income so will be tax this will decrease profit making people less willing to invest
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Why is the government sector important in an economy?
• Responsible for economic performance • Control and regulate activity (e.g. safety standards and minimum wage)
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How can governments use tax to influence economic performance?
• Use it to fund government spending which can increase performance • Influence consumption (taxing to discourage spending on unhealthy or imported goods)
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What is the fiscal policy?
To increase economic performance through government taxation and spending
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What is monetary policy?
Change monetary variables (interest rates, lending) to increase economic performance
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What policies do Keynesian economists choose?
Government intervention (fiscal policy)
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Which policy do neo-classical economists choose?
Private enterprise and market (monetary policy)
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What is the economic cycle
It is the continuous cycle for which an economy has good years (where there is high GDP), and bad years (where there is low GDP).
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How does an increase in GDP affect tax revenue?
• The average income increases, so there is an increase in revenue from income tax • Consumption increases, so there is an increase in tax revenue from sales tax.
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How does an increase in GDP affect government spending?
Employment increases and so there is less people depending on state benefit, and so government spending decreases (negative correlation)
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Name two types of Government spending
• Welfare benefits • Real spending (services)
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What is the name for the situation where government spending is grater then tax revenue?
Budget Deficit (Recession?)
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What is the name for the situation where tax revenue is greater than government spending?
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What is Structural deficit?
Miss management of government finances (play to votes for election)
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What is cyclical deficit?
Lack of activity in an economy, not due to mismanagement.
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Define international trade
Exchange of goods and services between nations
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How does a resection influence standards of living in an economy?
There is less exports and economic growth and so jobs are threatened and income decreases, and so standers of living decreases
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How does an increase of overseas prices influence standards of living in an economy?
The cost of imports and cost of living increases, meaning less people can afford necessities and so standards of living decrease
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What is free trade?
Trade based on open, competitive, international market with no barriers introduced by national governments
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How does an open market improve price and quality of goods in an economy?
Means there is a broader range of goods for consumers, who will choose the goods with the best quality and price. (consumer demand is being met at a lower price)Businesses will improve quality and price of goods to compete
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How does the removal of trade barriers improve economic growth?
It boosts production and there for employs resources –including labour, there for decreasing unemployment and increasing average income, improving standards of living and increasing consumption, this leads to more economic growth (multiplier effect)
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How does a competitive market increase the incentive to invest in a business
Suppliers reduce their cost of production in order to compete and reduce purchasing price. This will increase the demand for the good and increase the profit. this will increase the incentive to invest
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Why do economies benefit from national specialisation in an international market
• Different countries have advantages in production of different goods and so consumer benefits from best price and quality • Different countries have different resources and so consumer benefits from broader range of goods and services
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What is protectionism?
A situation where governments intervene in international markets to influence imports and export sales
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Name and explain 4 methods of protectionism (discouraging imports)
• Embargo (ban trade of a good) • Custom controls (delays, quality standees) • Quota (limit quantity of goods) • Exchange controls (restrict availability of foreign currency)
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How do tariffs increase sales of domestic goods?
The tariff (tax on imported goods) will mean the price of good is higher and so domestic goods find it easier to compete, and less needs to be imported to meet demand (as demand will decrease as well with the increase price).
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What is a disadvantage of tariffs?
Distorts markets, and so is not a good use of scarce resources
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How do subsidies encourage sales of domestic goods?
It enables domestic businesses to sell a good at a lower price in order to compete with imported goods. This increases the supply of the domestic goods increasing the demand for domestic goods meaning less needs to be imported to meet demand.
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What are 3 reasons for protectionism?
• Assist sunset industries • Assist sunrise industries • Improve balance of payments
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What are 3 problems with protectionism?
• Higher prices • Less access to goods and services • Inefficient production
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Why does protectionism help sunrise industries?
Removes competition from established foreign producers, increasing the demand, allowing domestic industries to grow.
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What is the problem with industries decline for governments, causing them to manage the decline?
Specialised resources and labour that is occupationally immobilised will become unemployed. Governments may be pressured to protect jobs in order to win elections.
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What is the name of the situation where total imports are greater than total exports?
Current account deficit
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What has happened to the dollar if it has had appreciation?
• Its value has increased • Its price has decreased in comparison to another • It has got stronger
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What has happened to the dollar if it has had depreciation?
• its value has decreased • Its price has increased in comparison to another • It has got weaker
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What are the consequences of the appreciation of a currency?
The price of exports increases so its demand decreases (depending on PED), so there is less activity and more unemployment in an economy and so government finances decrease
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What is the supply of dollars?
The quantity dollars have been sold (moved out) and exchanged into another currency
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What is the demand of dollars?
The quantity dollars have been bought (moved into) and exchanged from another currency
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Name 4 conditions of demand for currency (buying of $)
• Trade (exports) • Speculation of the increase in value of $ (for capital gains) • More attractive interest rates • USA owned assets outside USA profits.
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Name 4 conditions of supply for currency (selling of $)
• Trade (imports) • Speculation of the decrease in value of $ (for capital gains) • less attractive interest rates • Assets in USA owned by those outside USA profits.
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what is the purpous of macro economic model making?
to understand workings of economy, frame work of analysis, explain events
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define aggregate demand
total spending on domestic goods and services (relative to price level)
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define aggregate demand
total output of an economy (relative to price level)
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what does real GDP indicate?
national income, total output of an economy, individual standards of living, employment
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name 3 injections into the circular flow of income
government spending, Investment, exports
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name 4 leakages from the circular flow of income
indirect tax, direct tax, imports, consumers choosing to save
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how is AD/AS analysis used?
to predict outcomes and or explain background to specific economic phenomina
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what are the aspects of aggregate demand?
consumption, investment, government spending, net exports (imports minus exports)
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how does the monetary policy aim to help improve AD
quantitative easing (encourage lending), reducing interest rates. to encourage investment and consumption
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explain how quantitative easing works?
the central bank "lends" to banks by buying bonds (securities/dept). this is too help encourage banks to lend to businesses and consumers, improving consumption and investment
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what are the limitations to quantitative easing?
banks may hold on to funds, or invest in more attractive financial investment (e.g foreign financial market)
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how does the fiscal policy aim to improve AD?
uses government spending, and decreasing indirect and direct tax.
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how does government spending help improve AD?
in the short term, there is a direct demand for resources, employing more people and injecting into the circular flow of income. in the long term it can increase productive capacity
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how does decreasing indirect tax help to improve AD?
it can reduce the price of goods (depending on PED), increasing consumption
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how does decreasing direct tax help to improve AD
can increase post tax profit, incentivising investment, and increase disposable income increasing consumption
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what are the limitations to using fiscal policy to improve AD?
may leed to inflation, there is time lags. consumers may wish to save/pay off mortgages with extra disposable income, or may by imports instead. investment may not increase as there are other factors effecting desision making. "crowding out"
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what is "crowding out"?
when demand for funds increases, interest rates may increase actually reducing consumption and investment
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how do neoclasical goverments like to use taxation
not to effect AD, but only to fund government spending to reduce budget defficit
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why is LRAS curve curved?
when economy reaches maximum emplyment, AS is inelastic and an increase in AD will just cause inflation (production possibility is met), where there is less employed resorces, there is capacity to respond to change in AD so AS is elastic
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what are supply side policies?
policies that aim to improve economic performance by focusing on developing/improving the productive base of the economy
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how can privatization help to improve AS?
the businesses are now subject to the disiplis of market forces and privat enterprise, and so they respond to demand better and watch the cost of production, so they have more efficient production
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why can state ownership restrict AS?
decisions may be based on politics and are there for inefficient (votes),and there is a lack of incentives to be efficient
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what is neoclassical approach to improving AS?
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why do Keynesian politicians like state ownership
state ownership, to adopt a broader economic erspective, reduce externalities and social cost. they also try ro improve education and traing, support uni research to help boost Productive capacity (LRAS) and lower cost of production
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explain why there is a negative relationship between price level and aggregate demand
when price level increases, there is less consumption as peoples real income decreases, interest rates rise (demand for money increases), and there are less exports and more imports. less consumption leads to less activity.
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identify 3 government macroeconomic policy objectives
low inflation, full employment, economic growth, balance of payment (current account) equilibrium/surplus,
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state 5 supply side policies
privatization, deregulation, cut in state benefits, cut in income tax, increase laybor productivity
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what is actual growth?
a rise in real GDP, in the short run, a better use of existing capacity
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what is potential growth?
an increase in productive capacity of an economy
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when GDP falls for 6 months or more
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when GDP falls but refuses to recover
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what things can increase AS in the long run (productive potential)?
improved quality of resources (new technology, education), more factors of production (more laybour due to immigration, participation of women, or natural increse)
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what are the problems associated with growth?
more negative externalities (e.g polution, cars), uses resources restricting future growth, more stressful life (pressure of employment and tax)
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those who lack work and are actively seeking employment
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how do we measure unemployment?
claimant count or international laybour organisation (ILO) survey
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what is the limitations to using claimant count as an indication of unemployment?
many who are unemployed cannot/will not claim benefits, so it tends to understate actul figure
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why is unemployment a problem?
waste of scarce resorces, limits future growth (may loose skill or seen as "unemployable"), impact state finance, negitive externalities (cost of health and social unrest), lower standers of living
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what are the different causes of unemployment?
Cyclical unemployment, Frictional unemployment, Classical unemployment, structural unemployment?
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how my governments try to address cyclical unemployment?
use Demand side policies
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what is frictional unemployment?
Frictional unemployment is transitional unemployment due to people moving between jobs (e.g graduates)
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how my governments try to address frictional unemployment?
provide information about job vacancies, welfare system that benefits job seekers
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what is classical unemployment?
setting wage rate above market equilibrium (supply of laybour is greater then demand for it), false signal if high wages attracts people, further increasing unemployment
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how my governments try to address classical unemployment?
limit the power of union trade
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what is structural unemployment?
(due to increase in competition in another area or change in technology) people are unable to access work (locational immobility) or no longer have transferable skills (occupational immobility)
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how my governments try to address structural unemployment?
use subsidies to encourage people to move and provide info about work else where, encourage location of businesses in areas of unemployment using tax breaks and investing in infrastructure. and for occupational immobility retrain/ train workers
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how do we measure inflation?
using an index wich looks at how prices have changed in comparison to a base year, for an average family weekly shop (basket of goods)
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what is the difference between simple and weighted index?
simple compares average price rise for those goods, weighted is more representative as it looks at how relatively important each good is (% of shopping basket)
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what is a limitation to a weighted index?
there isarnt many people who are "average" and so individuals weekly shop is different to others. also the weight will change over time if incomes, fashions and technology change
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a sustained increase in the cost of production, living or general price level leading to a fall in purchasing power (real income)
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rapid inflation that devalues money quickly (making it worthless)-people use objects to trade instead
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what can cause a demand pull inflation?
a cut in tax (increase in disposable income), depretiation in exchange rates (less people by imports and demand for demestic goods increases, also exports are cheaper so demand for them increases), interes rates fall, economic bomb oversees (more de)
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what causes cost push inflation?
rising cost of production (labor, tax, interest rates,) depreciation in currency (imports are more expensive increasing cost of production e.g oil) unfair distribution of income (monopolies increase price)
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what is Balance of payments?
official records of countries iteration with a wider international economic world (records transactions based on trade and financial activities)
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what is current account?
record of the value of a countries exports and imports of goods and services and the income flows associated with economic assets
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what makes a current count deficit?
when the sum of funds out of an economy exceed the flow of funds in to it
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what policies are there to address current account deficit?
depreciation in currency, reduce consumption (less imports and it forcing companies to find forein markets increasing exports), protection policies
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what are the problems associated with depreciating a currency to improve current account deficit?
depends on PED as to how effective it is also can lead to inflation (cost of production and cost of living rise)
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what are the problems associated with reducing consumption to improve current account deficit?
cause unemployment (not a god use of resources), companies may decide to move abroad stoping the inflow of income all together, lowers standers of living political problems (votes), govt finances worsen
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what is a consequences of inflation? (real income)
people's real income drops (purchasing power falls and cost of living rises), consumption falls (AD falls). pressure on state to increase welfare (worsen govt finance), higher wage claimes (inflationary spiral) incresing cost of production
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what is a consequences of inflation? (competition abroad)
if inflation rate > competition, less demand for exports (more expensive), more demand for import (relatively cheaper). current account deficit and negative multiplier effect
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what is a consequences of inflation? (interest rates)
banks raise interst rates to save the value of their returns (not neccesseraly for savers) cost of borrowing increses (reducing investment) cost of mortgages increases (less consumption). also if inflation exceeds interest on savings now worse off
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define exchange rate
the price of one currency in terms of another currency/currencies
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define multiplier effect
process by which any change in a component of AD results in a greater final change in real GDP
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Other cards in this set
How do we assess economic performance?
• Output • International trade position • Unemployment • Inflation
What is output?
What is international trade position?
What is inflation?