Professional Documents
Culture Documents
Environment Causes
- Frictional Unemployment
Measures of - Demand Deficient
Taxation Non – Economic - Technological Unemployment
- Seasonal Unemployment
Economic Performance - Real wage / Classical
Measures - Structural Unemployment
Quality of
Life
Economic Growth
Social
Inflation
Investment
Types
increase AD
- Fiscal Policy
- Lower interest rate
- Stability
Causes of Deficit This is a record of all payments
High Inflation = This makes exports
A record of money for trade in goods and services
less competitive and imports more plus income flow it is divided into
competitive and expensive. flows in and out
4 parts
Exchange Rate = a rise in exchange
Balance of trade in goods
rate will raise exports prices and lower SPICED
import market. (visibles)
Economic Growth = If there is an Balance of trade in services
increase in AD and National Income (invisibles) e.g. tourism, insurance
increases, people will have more Net income flows (wages and
disposable income to consume goods.
Deficit Current Account investment income)
If producers cannot meet the demand Net current transfers (e.g.
then we have to import a lot more which
govt aid)
leads to a deficit.
Wealth Holds
Effects
G
3 leakages
Factors of
T
Savings Goods and
Production
Tax Services
Imports
- Economy will slow down as
less money in the circuit
- The leakages determine the Firms
size of the multiplier
X
M
3 injections Multiplier
Investment - The multiplier is the number of times a Wealth Effects
Government spending change in income exceeds the change in - Wealth is the sum of all assets in the economy.
Exports
net injections that caused it. - In UK most wealth is held in housing 60% and others
- The importance of the multiplier is that any include shares and capital assets.
- These increase the
change, the final impact is much greater - Wealth is a stock concept whereas income is a flow concept
circular flow and a
change is magnified
than the initial impact. - Wealth does not have a direct impact on circular flow of
- The greater the leakages the smaller the income.
by the multiplier
multiplier - However changes on wealth effect people spending and
- UK multiplier is 1.4 income patterns
- LEDC countries higher = higher growth
Aggregate Demand
Aggregate - AD is the total planned expenditure on goods and services produced in the UK.
Demand - AD = C+I+G+(X-M)
and Supply - Down sloping because:
- Lower prices in economy means increased international competitiveness so more exports and less imports.
- At higher price levels, interest rates are raised. So less investment and increased savings.
- A rise in Aggregate Demand is a necessary condition for a rise in Real National Output. However, if the economy is at full
Capacity (inelastic LRAS) then an increase in AD may not increase real output.
- Consumption
- Main component of AD.
- It measures the amount that consumers wish to spend at various price levels
- Determinants is
- consumer confidence, if consumers are confident then they will spend more
- Interest rates. High interest rates leave consumers with less spending money after housing costs.
- Housing markets. When house prices accelerate home owners can earn more form their houses.
- Investment
- Inverse relationship between interest rates and investment.
- Firms borrow from banks to invest so if high interest rates cost of borrowing rises and firms are less likely to borrow.
- A change in investment will change the level of AD; however a change in AD will also change the level of investment.
- Can be analysed using the accelerator.
- Gov. Spending
- Almost half of all spending in economy
- Does not need to equal tax revenue as the difference is either a budget deficit or surplus.
- The government can deliberately manipulate AD by overspending when there’s is a slowdown in economy. When there’s a boom they tax
more heavily.
- Net spending can also be increased ina recession, which will reverse the effect s of demand deficiency.
- Fiscal policy manipulates gov spending and taxation to change AD.
- Net exports
- Exports minus imports gives total movement of funds
- Reasons why value of net exports might change:
- Change in Exchange Rate = Strong Pound Imports Cheap Exports Dear. Demand for exports will fall and demand for imports rise. The stronger the
currency the worse the net value exports. Short run price elasticity inelastic as deals have been made.
- Changes in Global Economy = if USA have a recession they will buy fewer exports and will try to export more.
- In summary when any AD components rise, the AD curve shift to the right. This happens when any levels rise. They never fall just rise more
slowly.
Aggregate Supply
- Keynesian View = The equilibrium level of output can occur below full employment level of output.
- 3 sections: Spare Capacity, Bottle necks, Full employment.
- Spare Capacity
- The economy can increase without any pressure on cost and prices
- This is because there are unused resources as firms are not working at full capacity, or unemployed labour.
- AD would increase e.g. through fiscal policy, and real output would increase without causing an increase in price.
- Bottle Necks
- Constrictions in supply chain cause cost and wage pressure to build up.
- Certain type of labour which when in short supply can have increased prices.
- Eg 2012 Olypicis shortage of construction workers
- If AD increases then while the economy grows there will still be some inflation.
- Full Employment
- Full capacity
- No spare workers, so firms have to offer higher wages to attract workers.
- When AD increases short run extra spending but long run will be increased inflation with no increased output.
Policy
Exchange rate index and cut taxes. Lower taxes will increase consumers spending
House prices because they have more disposable income(C)
Economic Growth This will worsen the govt budget deficit
If the Bank of England anticipates inflation falling below the governments target of Tight Fiscal Policy
2% and economic growth is sluggish or the economy is facing a recession. They This involves decreasing AD
are likely to cut interest rates. Therefore the govt will cut govt spending (G)
Lower interest rates stimulate economic activity, as it reduces borrowing costs.
And or increase taxes. Higher taxes will reduce consumer spending
(C)
This increases the disposable income of consumers with mortgage interest
This will lead to an improvement in the government budget deficit
payments and should encourage spending.
Automatic Stabilizes
If the Bank feels the economy is growing too quickly and inflation is expected to
exceed the governments target, then they are likely to increase interest rates to If the economy is growing, people will automatically pay more
reduce the rate of growth and inflationary pressures. taxes ( VAT and Income tax) and the Government will spend less
How Monetary Policy Works on unemployment benefits. The increased T and lower G will act as
a check on AD.
In a recession the opposite will occur with tax revenue falling but
Liquidity Trap - When a cut in interest rates fail to stimulate economic activity. e.g. because of
increased government spending on benefits, this will help increase AD
low confidence.
the golden rule: over the economic cycle, the Government
Difficult to control many objectives with one tool - interest rates. The Bank could increase
interest rates to reduce inflation, but, it would cause economic growth to fall as well. will borrow only to invest and not to fund current spending;
Interest rates may affect some parts of the economy more than others. e.g. higher interest
Demand
rates increase the disposable income of people with savings. But, could cause homeowners to
be unable to afford their mortgages. Side
Policies
Increasing price flexibility and signalling in a
market = e.g. if government fail to increase
minimum wage then real wages would fall and
Education / Training =
there would be less unemployment. Firms cost Policies to designed
Investment in education and training and
of production also decreases and AS shift right. to increase AS encouragement to firms to train should
through labour and increase labour and productivity.
Increasing Competition =
product markets Reduction in Tax =
reducing constraints can
Lower taxes increase incentives to firms
increase competition. As firms
and potential workers.
compete they must either cut
3 ways to Examples Privatisation =
costs or become more
of
increase AS
Transfer from public to private. Private
efficient this shifts AS.
sector forms are in the best position to
Privatisation Policies
make decisions about what and how to
Deregulation
produce.
Improving Incentives = Function is to give higher Supply Deregulation =
rewards so people are more motivated.
Side Removal of regulations that affect firms.
Cut marginal tax rates Gives firms greater freedom to make their
Improving health, education, training sector Policies own decisions and increase competition.
Performance related pay and lower corporation tax. Easier for new firms to enter market
Time Lag =
Some policies (education) can
Effectiveness
take many years to have an
of polices effect on production costs.
Short run would increase costs