Notesale: Turn your study into money

Document Preview

Extracts from the notes are below, to see the PDF you'll receive please use the links above

---

Unit 4 Economics
International Economics
Ross Bateman

Definitions
Evaluation

Unit Content:
3
...
1 - Macroeconomic Indicators
The Economic Cycle
Economic Growth
National Income Data
Unemployment
Inflation & Deflation
3
...
2 - Managing the National Economy
Macroeconomic Models and Policies
Monetary Policy
Fiscal Policy
Supply-Side Policy
3
...
3 - The International Economy
Globalisation
Trade
The Balance of Payments
Exchange Rate Policy & Systems
The European Union (EU)

3
...
1 - Macroeconomic Indicators

Unit 4 - International Economics

The Economic Cycle
The economic cycle is a cyclical pattern of short-term fluctuations in GDP from year to
year
...
g
...
When people realise that the prices have risen considerably above their
real values, they sell to make a quick profit before its too late
...

❖ Political Cycles: Elected party make boom in run-up to election, then deflate the
economy to avoid demand-pull inflation after the election
...
One example is
storm damage in Gulf of Mexico leading to reduced demand in southern US states,
also affecting the supply of crude oil meaning a raised price of it and consequently
raised production costs
...
Increase in the value of national
output / national expenditure
...

❖ Potential Growth: Increase in maximum capacity
of the economy
...

❖ Technology: If technology improves, quantity of
factors of production improves
...
Affects
both labour and enterprise as well
...

Investment should raise productivity, technology
should raise productivity and education should
also
...

Demand-Side Economic Growth (Usually SR):
❖ Consumption (C): Income, confidence, wealth
effect, interest rates, tax, inflation
...

❖ Gov
...

❖ Net Exports (X-M): Exchange & interest rates,
income of foreign economies, free-trade
agreements, price competitiveness
...

Benefits of Economic Growth
❖ Higher incomes for population,
increased living standards
...

❖ More tax revenue through increased
national incomes
...

❖ More investment via accelerator
theory
...

❖ Environmental damage
...


National Income Data
Methods of measuring living standards:
❖ GDP (Gross Domestic Product): Output produced by resources within the UK
...

❖ NI (National Income): GNP - depreciation of the nation’s capital equipment
...
Excludes non-monetised sector
(i
...
unpaid labour and value of DIY)
...

❖ Distribution of Income: Real GDP per capita may rise, but the distribution of income
may become more unequal and some families may have become poorer
...

❖ Human Poverty Index (HPI): Emphasises 4 dimensions of human life: longevity,
knowledge, economic provision and social inclusion
...

2 ways of measuring unemployment:
❖ Claimant Count: Includes people who are eligible to claim the Job Seeker’s
Allowance - these people register with the government as unemployed
...

❖ Labour Force Survey: Covers people who have looked for work in the past month and
are able to start work in the next 2 weeks - tends to be the highest
...

Causes of Unemployment:
❖ Seasonal Unemployment: Unemployment caused
by a lack of demand for an occupation due to the
Demand-Side
time of the year
...

❖ Frictional Unemployment: Unemployment caused
by workers moving in-between jobs
...

❖ Classical Unemployment: Unemployment caused by real wages being kept above the
market clearing wage rate, leading to an excess supply of labour
...

❖ Higher government spending on the unemployed: Government has to pay more
benefits to those unemployed
...

Benefits of Unemployment:
❖ Helpful in keeping wage rates down
...

❖ Reduced environmental damage
...

… with Demand-Side Policies
❖ Fiscal Policy: Reflate the economy
through running a budget deficit;
increasing government expenditure
or reducing income tax rates
...


… with Supply-Side Policies
❖ Policies aimed at increasing the
quality and quantity of factors of
production: Improved technology
(creates jobs due to rise in exports),
improved education schemes (makes
people more economically mobile)
and increased investment for the
long-term
...
5% in UK)

The Phillips Curve
an economic
model showing
the trade-off
between inflation
and
unemployment
...
Also identifies the causes of inflation, e
...
inflation rises when
unemployment falls since, to reduce unemployment, aggregate demand must be strong
...

Page 6

Unit 4 - International Economics

NRU (Natural Rate of Unemployment): The Natural Rate of Unemployment is a result of the
sum of structural and frictional unemployment
...

This graph says that in the long-run, there is no
relationship between inflation and unemployment
...
The point at which LRPC =
SRPC is usually the natural rate of inflation as well
...

❖ Deflation is a persistent decrease in the cost of living or average price level
...

There are two ways in which inflation is measured, CPI and RPI:
❖ RPI (Retail Price Index): UK used to use this method
...

❖ CPI (Consumer Price Index): Most commonly used in UK now
...

The government aim for CPI to be 2% and for RPI to be 2
...

ONS publish the statistics for RPI and CPI
...
5% (CPI)
...

❖ Does not include house prices; even though mortgage repayments represent high
proportion of consumer spending
...

Page 7

Unit 4 - International Economics

Causes of changes in the price level (inflation):
❖ Demand-Pull Inflation: Caused by excess demand due to little spare capacity in the
economy
...
AD1 to AD2 = Little excess demand, whereas AD3 to AD4 is
purely inflationary
...
SRAS may shift because of increased prices of raw
materials, an increase in wages or increased taxation on firms
...


Consequences of Inflation
...

❖ Firms are able to increase prices &
profits before they pay higher wages
...

❖ Interest rates higher, investment
lowers via MEC
...

❖ Growth slowdown, fewer jobs
...

Page 8

Unit 4 - International Economics

❖ Fisher’s Equation: MV = PT (Money Supply x Velocity of Circulation of Money = Price
Level x Total Transactions)
Summary of Quantity Theory of Money: The government creates or condones an expansion
of the money supply greater than the increase in real national output
...

Inflation is difficult to forecast because:
❖ Energy prices are volatile
❖ The value of currency changes
❖ There is uncertain growth of demand

Good or Benign
Deflation

Deflation can cause consumers to delay their spending,
reducing demand due to expectations of the price level
to further fall in the future
...
SRAS & LRAS shift rightward, causing a
fall in price level but output & employment rise
...
Caused by a collapse of
aggregate demand, negative multiplier effects
and possibly a credit crunch
...
4
...

Historical Economics:
❖ 1980s:
➢ Thatcher into power in 1979 and focus on inflation has prevailed since
...

Page 9

Unit 4 - International Economics

❖ 1992-2008:
➢ No recessions, 64 quarters of consecutive positive economic growth
...
Evidence of low inflation, low
unemployment and steady growth
...

❖ 2008:
➢ Deregulation of financial markets came back to bite
...

UK Monetary & Fiscal Policy in the last 10 years:
➔ Base rates have remained at 0
...
30
...
Inflation is currently 0
...

➔ In 2009, the government pursued expansionary fiscal policy
...
This caused a big rise in government borrowing (2009-10)
...


Page 10

Unit 4 - International Economics

Monetary Policy
Monetary Policy is the part of macroeconomic policy that uses monetary instruments, e
...

interest rates, to achieve policy objectives, e
...
the control of inflation
...
Inflation can erode money’s future
purchasing power
...

Background on Objectives of Monetary Policy:
❖ For over 30 years, control of inflation has been the main objective of UK monetary
policy
...

4 functions of money:
❖ A medium of exchange: An asset accepted in exchange for goods and services
...

❖ A unit of account: Giving a product a monetary value
...

Money Supply: The total amount of money circulating in the economy
...

The Liquidity Spectrum
MOST LIQUID
Cash Shares

LEAST LIQUID
Current
Accounts

Deposit
Accounts

Treasury Bills

Property

Narrow Money (M0): Notes, coins and balances available for normal financial transactions
...

2 factors that determine the demand for holding money:
1
...
Higher the income, greater demand for money to facilitate spending
...
Rate of Interest
...
Higher the
rate of interest, the higher the opportunity cost of holding money
...
The
money saved by banks is used to lend out
...

Interest rates are set by the Bank of England on behalf of the government, the Monetary
Policy Committee (MPC) are responsible for them
...

❖ Demand-Side: Interest Rates go up, and AD goes down, inverse relationship
...


Interest Rates: DemandSide

Interest Rates: SupplySide

Transmission Mechanism:

Benefits of Interest Rates

Costs of Interest Rates

❖ Have a direct and powerful effect on

❖ Time lag (estimated to be 1 year for
Page 12

Unit 4 - International Economics

household spending
...

❖ Can be adjusted on a monthly basis,
contrasting discretionary fiscal policy
...

❖ Raising interest rates can impact
negatively on: investment, housing
market and balance of payments
...
Firstly, lower interest rates
discourage saving, meaning that there is more income available for consumption
...
Also, asset prices
increase, leading to the wealth effect and more confidence
...
Businesses bring forward
schemes that can now be run profitably because of a lower cost of borrowing
...

Evaluation:
❖ When is it appropriate?
➢ To control inflation - raising interest rates causes inflation to fall because it
encourages saving over spending, and because it affects investment
...

❖ Can interest rates be cut? (Currently at 0
...

Two groups of monetary policy instruments: those that affect the money supply and those
that affect the general public’s demand for money
...

❖ Demand: Manipulating interest rates
...
Therefore, households reduce their demand for credit
...

❖ Open Market Operations (OMOs): Buying and selling of government bonds in
exchange for money to either increase or decrease the money supply
...

The bank buys financial assets, mostly long-dated government bonds, previously held by
commercial banks - the bank purchased bonds using electronic money it had simply
created out of thin air
...

Is Quantitative Easing preferable?:
❖ Not been effective in stimulating recovery from recession and economic growth
...

❖ Blamed for serious adverse effects on the distribution of income (combined with low
interest rates)
...
Financial Markets → do with share prices
...

2
...

3
...

4
...

5
...

6
...


Page 14

Unit 4 - International Economics

Fiscal Policy
Fiscal Policy is the manipulation of public spending, taxation and borrowing to achieve the
government’s macroeconomic objectives
...

❖ Redistribution of income
...

Taxation is a withdrawal from the circular flow of income and can be split into both indirect
and direct taxation
...

An indirect tax is a tax on spending, including VAT
...


Types of Taxation

❖ Progressive Taxation: Proportion of a person’s
income paid in tax increases as income
increases
...

❖ Proportional Taxation: Proportion paid in tax
stays the same as income increases
...


The Laffer Curve

Adam Smith suggested that a ‘good’ tax is one that is
(4 Canons of Taxation):
Page 15

Unit 4 - International Economics

❖
❖
❖
❖

Equitable: Fair & based on taxpayer’s ability to pay
...

Convenient: Good payment method and timing
...


Modern Economists also add two more principles:
❖ Efficient: Meet desired objectives with minimal cost
...


Tax hypothecation is when taxes are earmarked for a specific purpose, e
...
the UK used a
large proportion of tobacco duty on NHS for smoking-related diseases
...

Merits of Indirect Taxation
...

❖ Correcting externalities, e
...
polluter
pays principle
...


… Arguments against Indirect Tax
❖ Distributional effects (on income
because regressive nature of tax)
...

❖ Lack of ‘announcement effect’ people unaware of what they’re
paying, against certainty principle
...
e
...

❖ Capital Spending: On hospitals, schools, roads etc
...
g
...

Highest area of government spending is social protection at £200bn
...

❖ To provide necessary infrastructure via capital spending on transport, education and
health facilities
...


Page 16

Unit 4 - International Economics

By running a deficit, at AD2, the change will be purely
inflationary with no change in output
...

A deficit usually shifts AD to the right
...

… poses a problem because:
❖ Financing the deficit
...

❖ A growing national debt
...

❖ Fiscal ‘crowding out’
...


… may be beneficial because:
❖ A stimulus to growth
...

❖ Demand management
...


Crowding out: Where a public sector deficit deters private sector investment and
consumption
...
It helps to judge how much of an
injection the economy needs
...

❖ Increase tax rates
...


Evaluation for fiscal:
❖ Classical economist says that a deficit would just be inflationary
...
The Golden Rule: States that the government could only borrow money to invest in
new social capital, such as schools & hospitals, over the course of an economic cycle
...
The Sustainable Investment Rule: States that over the economic cycle, public sector
debt is to be held at a ‘stable and prudent’ level of less than 40% of GDP
...
A condition of membership was set that government borrowing cannot
exceed 3% of GDP and national debt could not exceed 60% of GDP
...


Page 18

Unit 4 - International Economics

Supply-Side Policy
A supply-side policy is a long-term policy designed to increase the productive capacity of
the economy
...
They shift the LRAS curve rightward
...
As a consequence, there could be benign deflation
...

❖ Increase productivity
...

❖ Make the country more competitive
...

❖ Education & Training - Boost the
productivity of labour, which
increases the supply capacity of the
nation
...


Benefits of Supply-Side Policies
❖ Sustainable growth together with
stable inflation
...

❖ Improves quality & quantity of labour
force
...

❖ Deregulation - removal of barriers to
entry in an industry leads to the
creation of much more competitive
markets
...

❖ Might increase unemployment gap?
❖ Can be costly
...
As shown by the
diagram, if the economy is operating in a negative
output gap (AD1), there is no change in output from
the rightward shift of LRAS
...
4
...

Causes of Globalisation:
❖ Technological change - Communications technology has enabled easy, secure and
relatively cheap transfer of information, e
...
the Internet allows consumers to
compare prices on a worldwide basis before they decide to purchase products
...
Reduces costs of sea transport which is the way in which most goods are
transported internationally
...

Trade liberalisation is the removal or reduction of restrictions or barriers on the free
exchange of goods between nations
...

❖ Developing Country: A nation with a lower living standard, underdeveloped industrial
base and low HDI relative to other countries
...

… on Developing Countries

… on Developed Countries
Page 21

Unit 4 - International Economics

❖ Employment & better quality of life
...

❖ No guarantees that the wealth from
inward investment will benefit the
local community
...

❖ Increased inward investment,
encourages firms to invest in other
countries
...

❖ Structural unemployment
...


Multinational Companies (MNCs) are companies that are registered in more than one
country or that have operations in more than one country
...

❖ Willingness to accommodate to needs of local economy - in terms of employment,
training, environmental protection and health and safety considerations
...
g
...
Such tax incentives apparent reduce the level of fiscal revenues and
frequently create opportunities for illicit behaviour by tax administrators
...
MNCs profit maximise
so they may move before of cheaper production opportunities elsewhere and decide
to stop producing in a country
...

❖ Absolute Advantage: An economy can produce a good for lower costs than another less resources are needed to produce the same amount of goods
...
5 books: ⅔
➢ India has comparative advantage in textiles, as the opportunity cost is lower
...

Limitations of Comparative Advantage:
Page 23

Unit 4 - International Economics

❖ Increased specialisation may lead to diseconomies of scale
...

❖ Government’s may restrict trade
...

… on Developing countries

… on Developed countries

❖ More integration into the world’s
economy…

...
reducing poverty and
unemployment…
…leading to higher living standards
...


❖ Use cheap production elsewhere…
❖
...
and higher real incomes meaning a
higher standard of living
...


Foreign Trade Multiplier: The amount by which the national income of a country will be
raised by a unit increase in domestic investment on exports
...

❖
...

❖ More demand and more supply means more employment
...

Protectionism
...

❖ Domestic employment - protect own
labour market
...


… Arguments against:
❖ Welfare losses - massive
inefficiencies when countries aren’t
specialising
...

❖ Reduced choice - less imports
...
Is essentially
anything that reduces free-trade
...

❖ Quotas - Restriction on the number of imports
(make sure market doesn’t get flooded with good)
...

❖ Embargoes - Total ban of trade of a certain goods
...

❖ UK’s trade in manufactured goods has fallen relative to its trade in commercial and
financial services
...
e
...

WTO (World Trade Organisation): Responsible for dealing with the rules of trade between
nations at a global level
...


The Balance of Payments
Balance of Payments: A record of all the financial transactions that are made between all
those active in the domestic economy and the rest of the world
...

Current Account Composition:
1
...

2
...

3
...

4
...

UK NET Income Flows are positive, indicating that UK companies own more profitable
assets in the rest of the world that foreign multinationals own in the UK
...
g
...

❖ NET Portfolio Investment - purchase of financial assets, e
...
UK investor buying
shares in existing business abroad
...
g
...

Hot Money: Volatile capital movements which take place in the foreign exchange markets
due to interest rate changes
...

Capital is moved around the globe, e
...
buying and selling currencies they predict will
appreciate or depreciate, also referred to as ‘hot money’
...

❖ Long-term capital flows are divisible into direct investment and portfolio investment
...

… Benefits:
❖ Promotes growth of world trade
...


… Costs:
❖ Interdependence - difficulties in one
sector can affect the whole system
...


Financial Services in the UK:
❖ Financial sector accounts for 10% of UK exports
...

Balance of Payments Current Account Deficit: Imports > Exports
A current account deficit occurs when there is EITHER
- an outflow of money from the economy, a withdrawal from the circular flow of
income, leading to a reduction in national income and a negative multiplier effect OR
- when there is a lack of international competitiveness
...

➢ Fiscal Policy: Increasing income tax to reduce disposable income
...

➢ Recognises that UK citizens generally have a high marginal propensity to
import, so if people have less money to spend, they cut back reducing imports
...

❖ Expenditure-switching policies:
➢ Policies attempting to encourage consumers to switch their spending away
from imports towards the output of domestic firms
...

➢ Devaluation: Reducing the value of a currency in a fixed exchange rate system
...

Marginal Propensity to Import: The proportion of an
increase in income that is spent on imports
...


Balance of Payments Current Account Surplus: Exports >
Imports
A balance of payments on current account surplus may
be undesirable because:
❖ It is not possible for all countries to run surpluses
together: Countries with persistently large
surpluses must act to reduce these in order for
countries with balance of payments deficits to
improve their positions
...


Balance of Payments
Surplus

Page 27

Unit 4 - International Economics

❖ Can trigger domestic inflation
...
Results in demand-pull
inflation
...

❖ Removing direct controls on imports: Increasing free-trade by removing import
controls
...


Exchange Rate Policy & Systems
Exchange Rate: The price of one currency in terms of another
...

Floating exchange rates: Influenced by demand for a currency to:
❖ Purchase other country’s goods / services
...

❖ Speculation - buy currencies in the hope that they will rise in value
...


❖ These diagrams make the assumption that the exchange rate is $2:£1
...

❖ Demand for dollars comes from the UK, and supply of dollars to obtain sterling
comes from the US
...

❖ If the demand for the dollar increases as result of a change in taste in the UK towards
US goods, the demand curve shifts from D1 to D2, and the price of the dollar
increases from 50p to £1
...

❖ If increase in demand for dollars from the UK, there has to be a complementary
increase in the supply of pounds in exchange
...

… Advantages:
❖ Balances current account - e
...
a
country with large BoP deficit, ER will
depreciate, exports fall in price,
becoming more competitive
...


… Disadvantages:
❖ Effect on domestic inflation currency depreciation increases price
of imports
...


A floating exchange rate may not balance the current account out, as the total spent on a
country’s products depends on the price elasticities of demand for exports & imports
...
Relative interest rates - Increased IR leads to increased demand for sterling as hot
money flows into the UK
...

There will therefore be an appreciation of the pound, meaning imports are cheaper
whilst exports are dearer, causing structural unemployment as consumers have a
high marginal propensity to import, and now is
even higher due to cheaper imports
...
Inflation - If inflation is rising faster domestically
than it is in another country, the US for example,
this leads to a fall in US demand and an increase
in UK demand for US goods, as they are now
cheaper
...
Leads to
better current account position, but inflationary
pressures also
...
Foreign Direct Investment (FDI) - Increasing
flows of capital into an economy (in form of long-term investment funds, not hot
money) increases demand for country, leading to an appreciation of the pound
...
Current Account Deficits - Deficit means we are importing more than exporting,
meaning an increase in the supply of pound and a decrease in the demand for the
pound, leads to a depreciation of the pound
...


Fixed Exchange Rates

Variations of the fixed exchange rate:
❖ Adjustable Peg - Value of the fixed exchange
rate can be changed as circumstances require
...

❖ Crawling Peg - Frequent changes in the value of
a fixed exchange rate
...


Page 30

Unit 4 - International Economics

Fixed Exchange Rate
...

❖ Control of inflation - Maintains the
rate by restricting demand for foreign
currency
...

❖ Need regular revision - Countries
grow at different rates, and
differences in inflation levels mean
currency needed to be revised alot
...


Managed Float

A ceiling price and a floor price are set
...
At any higher
value to the pound, UK exports will be too expensive
abroad
...
At any
lower value, imports will be too expensive, exerting
inflationary pressures
...

In a dirty float, upper and lower levels are not published by the authorities, meaning
speculation is difficult
...


The European Union (EU)
Page 31

Unit 4 - International Economics

The EU was founded in 1993 and currently contains 28 member states
...

Institutional Structure of the EU:
1
...
Made up of ministers from each state
...
The Commission - Represents the interests of the EU as a whole and responsible for
ensuring that EU laws and policies are carried out
...

3
...
Number of seats a nation has reflects the size of the population
from that country
...

4
...
Rulings here
become part of the EU law and all EU countries will be bound to it
...

5
...

The Euro is currently used by 19 of the 28 members, and was established in 1998 with
its headquarters in Frankfurt
...
3 key functions of the ECB:
a
...

b
...

c
...

Eurozone: The countries in the EU
that have adopted the single
currency
...
g
...

Single Market…
… Advantages:

… Disadvantages:

❖ Economies of scale - scope for
countries to exploit the economies of
scale and division of labour, leading
to a rise in productivity
...

Consumers benefit in the form of
cheaper products and more choice
...

❖ Inefficiencies - due to separate
national markets still in existence,
market hasn’t been fully opened up
causing inefficiency
...
Larger Export Market - Potential to increase exports due to more countries to sell to
...
Powerful Counterweight - Seen by the UK as a powerful counterweight to the
combined power of Germany and France
...

❖ Added only 5% to EU’s GDP
...

European Monetary Union (EMU): A group of countries that have adopted the euro and
have their monetary policy controlled by the European Central Bank
...

… Benefits of:
❖ Reduced transaction costs eliminates cost of foreign exchange
transactions
...
Increased
economic growth
...
g
...


reducing AD
...


Page 34



---