Notesale: Turn your study into money

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Costs and benefits of economic growth



Short run economic growth – increase in real GDP
Long run economic growth – increase in the productive capacity of the economy – shift in LRAS

Benefits
1
...
Unemployment reduction
a
...
Positive impact on government finance
a
...
Revenue from taxes on goods and services will rise as a result of an increase in
consumption
4
...
If firms know demand is going to increase, they will invest in more capital etc… to
produce more
Costs (of uncontrolled levels of growth)
1
...
Capital intensive growth
i
...
Industry dependent growth
i
...
g
...
Those that work in the il sector – might not see a trickle down effect
2
...
Philips curve – higher growth equals lower unemployment but higher rates of inflation
3
...
Pollution
b
...
Future generations won’t be able to benefit in the same way
c
...
E
...
waste dumped in rivers – unsustainable growth
 Evaluation: Sustainable growth – short run demand fuelled growth and long run supply fuelled
growth

Costs and benefits of inflation
Inflation – rate at which money loses value – general price levels rise in the economy
Benefits
1
...
Incentivises production of firms – incentive to produce more as prices will be higher
3
...
If inflation is relatively high, firms can increase the workers’ wages at a rate lower than
the inflation rate, thus workers are happy because of higher wages, firms keep a lid on
costs, and unemployment does not increase
4
...
Incentivises you to buy now
b
...
Reduction in purchasing power of consumers
a
...
Menu costs
a
...
Shoe leather costs
a
...
There are many costs when transferring money to another bank
4
...
E
...
if your salary increases by 3% and inflation increases by 3%, and that increase in
salary leads to moving up a tax band that has not been adjusted for inflation, then you
are being harmed by that increase
5
...
Makes exports less competitive, and imports more competitive – not good for a
country’s trade position
6
...
Wage price spiral
i
...
As they increase prices, this
causes more inflation – continues as a spiral
b
...
Likely to buy things now rather than later when prices would be higher, increase
in consumption causes an increase in AD which further increases inflation –

spiral
7
...
If consumers and producers are not sure what is going to happen in the future, they are
likely to reduce their spending
8
...
Cause
a
...
Cost push – more detrimental
2
...
If only short term high inflation, some negative effects might not happen
3
...
Might cause spirals
4
...
Higher than targeted – more likely to have more costs than benefits
Costs and benefits of unemployment
Benefits (of some unemployment)
1
...
Workers have time to search for the best job for them (some frictional unemployment)
Costs – economy
1
...
Deterioration of government finances
a
...
Lower tax revenue collection (income tax)
c
...
If use borrowing  debt
ii
...
Hysteresis
a
...
Longer outside workforce then skills deteriorate – even harder to compete with
other workers + employers get a bad image
1
...
If depend on benefits – less consumer spending so AD decreases
4
...
Reduced trade in other countries – high unemployment = less imports
Costs – individual
1
...
Loss of status (self-worth)
a
...
Type  duration
a
...
Structural – if people don’t have correct skills, can lead to long term unemployment
c
...
Severity
a
...
More than that has costs
3
...
Can reduce some costs e
...
loss of income and social costs – however might encourage
workers to stay on benefits
Economic cycle – features and causes

recovery

recession

Boom






Rapid growth caused by consistent increases in AD – generates higher incomes and thus higher
consumer and business confidence
Lower unemployment – labour is a derived demand – more demand for goods and services =
more demand for labour
Investment increases as businesses become more confident and spend more on capital
Higher inflation
Higher tax revenues – income and corporation taxes (and VAT)

Slowdown and recession




Decrease in AD and consumer confidence
Increase in unemployment
De-stocking and price discounts

Recovery







Higher house prices = consumers more willing to borrow money – higher consumer confidence
Higher investment – higher business confidence
Increase in consumption
Lose macroeconomic policies – to prevent double dip recession
Rise in construction and manufacturing
Increase in growth and fall in unemployment
Causes of

Recession

Demand
Economic shocks e
...
:
 Bankgin crisis
 Housing market crash
 Currency crises






Recovery sharp increase of growth



Multiplier effect
Accelerator effect
Balance of payments

The inflows and outflows of money into and out of a country
...
g
...
g
...
Lower AD (X – M) is negative
Depreciation of the pound

LRAS

Price of £ in $
S1
S2
P1

E1

Pl2
E2

Pl1

AD1

D

AD2
Y1



Q1 Q2

Y2 Real GDP


Decrease in growth
Higher unemployment

Debt burdens


Quantity of £

If a country does not have a very
strong export base, a weaker
exchange rate will harm the economy
and may lead to stagflation

If a country with a current account deficit keeps borrowing money by selling bonds for example,
to have a financial account surplus, other countries will start doubting whether that country will
be able to pay back all the debt and will stop buying bonds
...

Fixed and floating exchange rates

To support a fixed exchange rate, the government or central bank require to hold large amounts of
currency reserves (domestic and foreign)
...
Thus this problem is avoided with
fixed exchange rates
Discipline on domestic producers
o Have to increase efficiency instead of relying on more sales because of a lower exchange
rate

Drawbacks


Interest rate effects
o If interest rates are used to maintain a fixed exchange rate, then, if fixed exchange rate
is set at a level where current exchange rate is lower, then the current exchange rate
needs to rise to meet the exchange rate, which may mean raising interest rates
...
Lower growth  Potential current account deficit
2
...
Higher unemployment in domestic industries – domestic industries have to compete with
imports from abroad – may need to sack workers if can’t compete
Pros
1
...
Cheaper imports  higher standard of living
3
...
Higher employment in exporting industries
2
...
Higher inflation  demand pull and cost push

Evaluation




Extent to which currency appreciated or depreciated
PED of net exports – marshall-lerner condition and J-curve effect
Restrictions on trade e
...
if exports cheaper but there are barriers – may reduce some of the
benefits

Floating exchange rates and the current account
UK – large current account and trade deficit – importing more than exporting – thus, there is more
supply of the pound than there is demand for the pound, thus overall, the impact of a current account
deficit and a trade deficit is that the supply of the pound is increasing, thus reducing the exchange rate
of the pound (depreciates)
Price of £ in $
S1
S2






P1
P2

Cheaper exports
Dearer imports
Thus net exports should increase
Positive effect on the current account

D
Q1 Q2

Quantity of £

Marshall-Lerner condition and the J-curve effect
The Marshall-Lerner condition states that a currency depreciation will only correct a current account
deficit if
𝑃𝐸𝐷 𝑋 + 𝑃𝐸𝐷 𝑀 > 1
PED & TR
Elastic
Increase in P = Decrease in TR
Elastic
Decrease in P = Increase in TR
Inelastic
Increase in P = Increase in TR
Inelastic
Decrease in P = Decrease in TR
Elastic Opposite Inelastic Same



Current
account
+

-

Weak currency
PEDX inelastic – Price falls TR falls
Exports revenue decreases
PEDM inelastic – Price increases, Total expenditure increases
Import spending increases
PED(X – M) inelastic (<1) Price decrease = TR decrease
Leads to a worse current account deficit

It can be argued that the equation might not hold in the short run as consumers and producers
take time to adapt and change their purchasing habits, thus the amount spent on imports does
not change
...
And only as people start to
adjust to a lower exchange rate, and
Time reduce import expenditure, and foreign
countries start to increase their buying of
exports, only then will the current account
start to improve, but that takes time
...
00 = $1
...
If we convert 1000 pounds into dollars,
we can buy exactly the same amount of goods and services in the US as in the UK, and vice versa
...
00 = $1
...
The pound is undervalued according
to this nominal exchange rate, as the pound can buy less in the US than it can in the UK
...

Real exchange rate should be £1
...
70
...


Fiscal policy and borrowing
Budget deficit (Public Sector Net Cash Required) where Government spending > tax revenue in a fiscal
year
...

Interest rates are the
Interest rates
S1
P2
P1

D1
D
Q1


Quantity

If the government has to spend by excessive amounts of
borrowing, then you can expect a crowding out effect,
where in the loanable funds market, demand increases
excessively, increasing interest rates
...

Multiplier and accelerator effects

Multiplier – process by which any changes in the components of AD will lead to an even greater change
in national output
𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 =

1
1
1
=
=
1 − 𝑀𝑃𝐶
𝑀𝑃𝑊
𝑀𝑃𝑆 + 𝑀𝑃𝑇 + 𝑀𝑃𝑀

MPC – Marginal Propensity to Consume – out of every pound, how much is spent on consumption e
...
if
my income is £50 and I spend £25, my MPC is 0
...


MPW – Marginal Propensity to Withdraw = Marginal Propensity to Save + Marginal Propensity to Tax +
Marginal Propensity to Import
E
...
Government spending increases by £100 million and MPC is 0
...

𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 =

1
=5
1 − 0
...

Accelerator – changes in investment can be directly linked to changes in the rate of GDP growth



When rate of GDP growth is increasing, firms will be more willing to invest, as they believe
demand will be higher in the future – facilitates quicker increases in GDP growth rate
If the rate of GDP growth starts to slow down, the opposite will be true, whereby firms will hold
back spending, reducing AD – facilitates quicker decreases in GDP growth rate

How does monetary policy work?
S3

Interest rate

S

1
...
To decrease interest rates, reduce reserve requirement
b
...
Discount rate
a
...
To increase interest rates, increase discount rate –
make it more expensive for banks to borrow money
from central bank thus amount of money in economy
decreases
3
...
To decrease interest rates, buy bonds
b
...





Low availability of credit
Low consumer/business confidence
Low willingness of banks to lend

1
...

3
...

5
...
Access to credit improves, general interest rates decrease, and the willingness to lend should
increase at lower interest rates
7
...
Transfer payments
a
...
Child support
c
...
Government spending on essential goods and services  goods/services that generate positive
externalities
a
...
Education
BUT  huge cost to government – opportunity cost

3
...





Taxes become high to the point where workers are disincentivised to work, and cut back on
their productivity
Entrepreneurial spirit held back
These harm economy

4
...
Government finances
2
...
If gov decides to increase progressive tax bands, we can question whether the laffer
curve effect will actually reduce the overall effectiveness of this policy
b
...

Determinants of whether a country is competitive or not:
1
...
Non-price competitiveness
a
...
g
...
Ability to attract factors of production (FDI)
a
...
g
...
ULC (unit labour cost)

𝑇𝑜𝑡𝑎𝑙 𝑙𝑎𝑏𝑜𝑢𝑟 𝑐𝑜𝑠𝑡
𝑂𝑢𝑡𝑝𝑢𝑡

a
...
GCI (global competitiveness index)
a
...
TOT (terms of trade)
a
...
The higher the number, the better the terms of trade but the worse the price
competitiveness of a country’s goods and services
Factors that determine international competitiveness
1
...
Labour flexibility
a
...
Are workers willing to work part time etc…
3
...
Tax regimes
a
...
Will improve price and non-price competitiveness
c
...
Innovation
6
...
Boosting efficiency of domestic firms
b
...
Regulation
a
...
With less strict regulation – lower costs and attracts FDI
8
...
The more stable the economy, the easier it becomes to attract FDI

UK: ranked highly on GCI



Very competitive (non-price and FDI)
Locking price competitiveness in key sectors
Policies to improve international competitiveness

Supply side policies




Price competitiveness
Non-price competitiveness
Attracting FDI

1
...
New roads, bridges etc…
i
...
Tax incentives
a
...
Lower corporation tax increases the retained profits in businesses, which they
may use to invest e
...
on new technology, new capital, innovation, R&D etc…
b
...
Up to a given threshold, if a business keeps the profits for investment purposes,
they will not be taxed on that money
3
...
Take away overly strict laws such as stringent environmental laws etc… reduces cost of
production
b
...
Government spending on education
a
...
Or curricular reform
b
...
Improving productivity drives down unit labour costs

BUT
1
...
What will the effect be on the future
i
...
Will some money going to other sectors be cut
2
...
Time lag
a
...
Targeted?
a
...
g
...
Relative concept
a
...


Benefits of free trade
Price of coffee

SBrazil
A





P1
B

D

PW



E

SW

C
D

Q2

Q1

Q3

Quantity

Imports


SW is horizontal because world supply is so high, that
producing any quantity Brazil could produce is so
easy that suppliers don’t need an increase in price in
order to do so
...
5 computers

2 cotton

Ghana

1/8 computers

8 cotton

Comparative
advantage

Computers

1 Computer

Ghana

India

1 Computer

10
Ghana’s Opportunity Cost Ratio

India’s PPC

2

India’s
OCR

Ghana’s PPC

16


20

2

Cotton

To determine the country with the
comparative advantage, go to the axis
with the biggest gap between the two
curves, has got the comparative
advantage in whatever is on the axis





8

Terms of trade should be 1
computer for 2 – 8 cotton
1 computer for >5 cotton is
more beneficial to Ghana
1 computer for <5 cotton is
more beneficial to India

Quantity and quality of factors of endowment will determine which goods a country has a comparative
advantage in
...
g
...
Perfect knowledge
a
...
No transport cost – distorts comparative advantage
a
...

4
...

6
...

8
...
Infant industry argument
a
...
Short term protectionism
2
...
A country may have excess supply of goods due to having subsidised domestic
businesses for example, and thus decide to sell the excess amount abroad for a price
lower than production cost
...

b
...
Protect domestic employment
a
...
Protect against ‘unfair’ low cost labour abroad – Asia
5
...
To protect against poor quality goods entering your country
6
...
To improve a current account deficit (increased economic growth)
a
...
To avoid the risk of over-specialisation
a

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