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Title: A* Economics Notes Theme 1 and 2
Description: A* Notes on As Economics for first year A-Level takers with detailed information and detailed diagrams.
Description: A* Notes on As Economics for first year A-Level takers with detailed information and detailed diagrams.
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AS Edexcel Economics
Theme 1 – Markets and market failure
Unit 1
•
•
•
•
•
•
1
...
1 Economics as a social science
1
...
2 Positive and normative economic statements
1
...
3 The economic problem
1
...
4 Production possibility frontiers
1
...
5 Specialisation and division of labour
1
...
6 Types of economies (free market, mixed, command)
How markets work
•
•
•
•
•
•
•
•
•
•
1
...
1 Rational decision making
1
...
2 Demand
1
...
3 Elasticity of demand / income / cross
1
...
4 Supply
1
...
5 Elasticity of supply
1
...
6 Price determination
1
...
7 Price mechanism
1
...
8 Consumer / producer surplus
1
...
9 Taxes and subsidies
1
...
10 Alternative views of consumer behaviour
Market failure
•
•
•
•
1
...
1 Types of market failure
1
...
2 Externalities
1
...
3 Public goods
1
...
4 Information gaps
Government intervention
•
•
1
...
1 Government intervention in markets
1
...
2 Government failure
Theme 2 -‐ The UK economy -‐
Performance and policies
Unit 2 -‐ starts on p
...
Measures of economic performance
•
•
•
•
2
...
1 Economic growth
2
...
2 Inflation
2
...
3 Employment and unemployment
2
...
4 Balance of payments
Aggregate demand
•
•
•
•
•
2
...
1 Aggregate demand (AD)
2
...
2 Consumption (C)
2
...
3 Investment (I)
2
...
4 Government expenditure (G)
2
...
5 Net trade (X-‐M)
Aggregate supply
•
•
•
2
...
1 Aggregate supply AS
2
...
2 Short-‐run AS
2
...
3 Long-‐run AS
National income
•
•
•
•
2
...
1 National income
2
...
2 Injections and withdrawals
2
...
3 Equilibrium real national income
2
...
4 The multiplier
Economic growth
•
•
•
•
2
...
1 Causes of economic growth
2
...
2 Output gaps
2
...
3 Trade (business) cycle
2
...
3 Impact of economic growth
Macroeconomic objectives and policies
•
•
•
•
2
...
1 Possible macroeconomic objectives
2
...
2 Demand-‐side policies
2
...
3 Supply-‐side policies
2
...
4 Conflicts and trade-‐offs between objectives and policies
...
Provide information to help make informed judgements
...
Look at how different economic models may predict certain outcomes
...
There are many different variables that are difficult to control
...
Economics is not an exact science
...
In Maths
2+2 always equals 4
...
Ceteris paribus
This means ‘all other things being equal’
...
For example,
•
•
Ceteris paribus – higher oil prices should lead to less demand for oil
...
Positive economic statements
This is based on facts that can be tested as true of false
...
In May 2015, the UK inflation rate was 0
...
2
...
Normative economic statement
This is based on an opinion or a value judgement
...
For example:
1
...
2
...
Combining positive and normative statements
•
•
Because oil prices have increased over $100 (fact), I believe the
government should cut petrol tax (opinion)
Because oil prices have increased over $100 (fact), I believe the
government should subsidise the development of alternative modes of
transport, such as cycling (opinion)
...
It can depend on what people think is more important
...
b) With subsidising public transport, economists may be concerned with the
environment and the external costs of oil
...
• Non-‐renewable resources
...
Once used, they cannot be replaced
...
• Renewable resources
...
Examples
include wind, wood, fish, solar energy, water
...
There are some resources that, in theory,
are renewable, but if they are over-‐consumed they can become extinct
and no longer available
...
But,
if we over-‐fish, fish stocks can become depleted and no longer available
...
This occurs when we consume resources at a
rate that can be maintained in the long-‐term
...
If we plant at the same rate as
cutting, this is sustainable
...
For example:
• If the government spends tax income on defence spending, then this
money cannot be spent on health care
...
• If we spend our time surfing the internet, we cannot spend this time
studying economics
...
Importance of opportunity cost
• Opportunity cost means we have to make decisions about the best use of
time, money and resources
...
Choice between study and leisure -‐ Suppose we have 12 hours to spare
...
If we move from A to B, we can spend two hours on leisure
...
Production possibility frontiers (PPF)
A PPF shows the maximum output that an economy can produce if the economy
is maximising the use of its resources and operating efficiently
...
It is
impossible to choose more consumer
goods or environment units without an
opportunity cost
...
• If we produce more consumer goods, it leads to a depleted environment
...
Opportunity cost and production possibility frontier
• At point A, we have 15 goods / 22 environment
• At point B, we have 11 goods / 25 environment
...
• However, the opportunity cost is that we have to forego 4 units of
consumer goods
...
• Consumer goods – Goods that we can use and enjoy
...
• Capital goods – These are goods that are used in the productive process – for
example, a machine
...
• If we move from A to B, there is a movement along the PPF curve enabling
more consumer goods to be produced (an extra 3)
...
• Increasing consumer goods enables higher living standards in the short
term, but in the long term we may not be able to produce as much
because of less investment in capital goods
...
Economic growth and a shift in the PPF curve
• Economic growth enables the PPF curve to shift to the right, enabling
point C (more consumer goods and capital goods)
...
Causes of economic growth
•
•
•
•
Discovering more raw materials (e
...
discovering oil fields)
Increase in the size of work force (e
...
immigration)
Increase in capital stock (e
...
investment in new machines, factories)
Increase in labour productivity (e
...
due to better technology)
Specialisation and division of labour
•
•
Specialisation occurs when a country or firm concentrates on producing a
particular good or service
...
For example, Japan specialises in producing high-‐tech electronic
goods
...
Division of labour
•
•
•
This occurs when workers concentrate on different tasks within a firm
...
For example, in a car-‐building firm, some will
work on design, some on testing, and some workers will just do unskilled
jobs such as painting the car
...
Advantages of specialisation in the production of goods
•
•
•
The division of labour gives workers time to gain skills for one particular
job
...
With specialisation and the division of labour, firms can be more efficient
when producing on a large scale; it enables economies of scale, and lower
average costs
...
But the division of labour makes a big
production task manageable by spreading the work out
...
•
On an assembly line, if one person is absent, the whole production line
may slow down if other people can’t cover their job
...
Advantages of specialisation in trade
•
•
•
•
Specialisation means countries don’t have to produce every good they
need, which would be impractical for small countries
...
g
...
It enables countries to import goods that they otherwise wouldn’t be able
to produce (e
...
you can’t grow bananas in UK; African countries don’t
currently have a viable car industry)
...
Problems of specialisation in trade
•
•
Concentrating on producing a small number of goods can make an
economy vulnerable
...
It may hamper development if countries stick to producing primary
products, which have a low-‐income elasticity of demand
...
It
can have intrinsic value like gold or it can be in the form of notes and
coins distributed by a central bank
...
For
example, a teacher gets paid money and can buy food from supermarkets
...
(e
...
a pig farmer is unlikely to sell me some pork in
return for a few hours of economics tuition)
Functions of money
1
...
Money should be accepted universally for the
payment of goods and debt
...
Unit of account
...
g
...
3
...
If you save money in the bank, you can keep part of your
income to spend in the future (inflation means cash tends to reduce value
over a period of time)
4
...
Money is used to pay back debt
...
Types of economy
A free market economy
A totally free market occurs where there is no government intervention in the
economy
...
Decisions on what to produce and how to produce goods are left to
market forces
...
Advantages of free market economies
•
•
•
•
•
Free markets tend to result in an efficient allocation of resources because
firms have a profit incentive to produce goods that are in demand
...
Consumers have the freedom to choose the best products, which they
need
...
The incentives of a free market encourages individuals to work hard and
set up new business
Disadvantages of free market economies
•
•
•
•
Private firms can gain monopoly power, leading to higher prices for
consumers and greater inequality
...
Merit goods like education will be underprovided
...
There will also be
over-‐consumption of demerit goods like alcohol and tobacco
...
In a free market, some will accumulate high levels of
wealth and have high salaries, but others may experience unemployment
and low wages
...
(e
...
the former Soviet Union)
...
The government can take into account externalities and protect the
environment
The government can prevent the abuse of monopoly power
...
Problems of command economies
•
•
•
•
•
There is no profit motive, so people working for the government may
have little incentive to cut costs and innovate
...
The government may be slow to respond to changing consumer
preferences; with price controls, we may end up with shortages or
surpluses
...
Consumers may face a lack of choice about goods to buy
...
Mixed economies
A mixed economy involves a degree of government intervention in parts of the
economy
...
However, the government will:
•
•
•
•
•
•
Implement taxes on income and goods (e
...
VAT)
...
Regulate markets, e
...
monopolies, regulations on the environment and
demerit goods (smoking bans)
...
Most modern economies are mixed, with different levels of government
intervention
...
In Sweden, government expenditure amounts to over 50% of GDP
...
Rational decision making
In economics we assume firms and consumers are rational
...
Utility
This is the concept of how much benefit people get from consuming a certain
good
...
We assume consumers wish to maximise their utility
...
Profit
This is the amount of money a firm gains after subtracting costs from its total
revenue (profit = total revenue – total costs)
...
For example, if a good is no longer profitable, they will try
switch to something else
...
Firms may try to increase market share as a method to increase profit in
the long term
...
For example consumers may use demerit goods (alcohol, tobacco) that
damage their health
...
Firms may not always maximise profits, but have other objectives
...
Firms and consumers may also have altruistic aims – for example, they
may be willing to put environmental, political or charitable concerns
above issues of profit
...
The market demand curve illustrates the price consumers in the whole economy
are willing to pay
...
•
•
A higher price reduces demand
...
•
For example, if there is an increase in price from 9 to 12, then there will
be a fall in demand from 30 to 22
...
If the
price is higher, this discourages people from buying the good
...
An increase in disposable income, such as higher wages and lower taxes
giving consumers more spending power
...
An increase in the quality of the good
...
3
...
4
...
For example, if the price of O2
Mobile phone calls goes up, the demand for Vodafone mobiles will
increase
...
A fall in the price of complements
...
Evaluation
•
•
It depends on the type of good
...
Some goods will vary due to seasonal factors like the weather and time of
year (e
...
scarves and air conditioners)
...
•
•
•
•
•
The first chocolate bar of the day is likely to give the highest utility
...
If you have already eaten three chocolate bars, you are unlikely to enjoy a
fourth
...
As you consume more goods, the utility of the extra goods usually
declines
...
You
wouldn’t want to pay as much for the fourth chocolate bar as the first
...
Therefore, as quantity
increases, we are willing to pay a lower price
...
They are
willing to pay lower prices for a higher quantity
...
(Therefore, the price rises by £12)
12/60 = 0
...
2×100 = 20%
We have a 20% increase in the price
...
)
Elasticity
The price elasticity of demand measures the responsiveness of demand to a
change in price
...
Example of elastic demand
•
If the price of Tesco bread increases 5% and demand falls 15%, the PED is
(-‐15/5) = -‐3
...
This is price elastic
...
Competitive markets
...
Frequently bought
...
Inelastic Demand
•
•
Demand is price is inelastic if a change in price leads to a smaller
percentage change in Q
...
PED will be less than -‐1 (e
...
-‐0
...
2
Characteristics of inelastic goods
•
•
•
•
•
Few substitutes
...
g
...
Necessities, e
...
if you have to drive to work, you need to buy petrol
...
If you are addicted you will pay higher price e
...
cigarettes,
coffee
...
In the short term, demand is usually more inelastic because it takes time
for consumers to find and switch to alternatives
...
Demand for a good like coffee is likely to be inelastic, as there are few
substitutes to coffee
...
g
...
2
...
In the short term, demand for petrol is
inelastic, but over time, people may be more willing to switch to
alternatives, such as cycling to work, so that demand for petrol becomes
more elastic with time
...
Revenue
If demand is inelastic then increasing the price can lead to an increase in revenue
...
•
•
•
Revenue was $110 × 9 = $990 million
Revenue is now $190 × 8 = $1,520 million
An increase in revenue of $530 million
This is why OPEC tries to increase the price of oil, because higher oil prices are
more profitable
...
D 1/9 = -‐0
...
1%)
% change in price 80/110 = 0
...
7%)
Therefore PED of oil = -‐11
...
7 = -‐0
...
5%
Revenue was 110 × 9 = £990
Revenue has now fallen to 4 × £130 = £520
A fall of £470
PED of this example -‐55/18 = -‐ 3
...
Advertising and elasticity
•
•
•
•
Firms have an advantage if demand for their good is price inelastic
...
This is why many firms spend money on advertising to create brand
loyalty
...
Firms can make demand more inelastic by offering more add-‐on features
and better quality products that stand out from the competition
...
After tax is placed on the good, supply shifts to S2
...
The price rises from £80 to £140
...
In this case, consumers face most of the tax burden
...
(10 × 72) = £720 (producer burden)
Income elasticity of demand (YED)
Income elasticity measures the responsiveness of demand to a change in income
...
g
...
Types of good
•
•
•
•
Inferior good
...
Inferior goods will have a negative YED
...
As your income increases,
you buy better quality goods instead
...
This occurs when an increase in income leads to an
increase in demand for the good, therefore YED>0
...
Luxury good
...
It means demand is
income elastic
...
Income inelastic
...
Therefore 0 > YED < 1
...
Demand for inferior goods will increase
...
Supermarkets may respond to a recession (falling income)
by supplying more ‘inferior’ goods
...
•
E
...
if the price of milk falls by 10%, demand for tea may increase 1%
...
1
Substitute goods
...
With
two substitute goods, XED will be positive
...
Tesco bread and Sainsburys bread are close substitutes so XED is higher
...
These are goods that are used together
...
•
For example, if the price of DVD players fall, then there will be an increase
in demand for DVD discs
...
If the price of lamb increases, we would expect it to have no
effect on the demand for beer or computers
...
Supply
The supply curve refers to the quantity of a good that the producer plans to sell
in the market
...
If price changes, there is a movement along the supply curve
...
g
...
Joint supply
Joint supply occurs when two goods are supplied together from the same source
...
With an increase in the supply of beef, you also get more leather
...
g
...
This could occur for the following reasons:
•
•
•
•
•
•
•
•
A decrease in costs of production
...
Lower costs could be due to lower wages or lower raw
material costs
...
Expansion in the capacity of existing firms, e
...
investment to extend the
size of a factory
...
g
...
Favourable climatic conditions, which are very important for agricultural
products, e
...
good weather will give a good harvest
...
g
...
Lower taxes on the good, e
...
lower petrol tax
...
Price elasticity of supply
This measures the % change in quantity supplied after a change in price
...
Perfectly inelastic means a change in price has no effect on supply
...
6 (inelastic supply)
Supply could be inelastic for the following reasons:
1
...
If firms are operating close to full
capacity, it is difficult to increase supply
...
Low levels of stocks; therefore, there are no surplus goods to sell
...
In the short term, capital is fixed, therefore firms do not have time to
build a bigger factory and increase supply
...
Difficult to employ factors of production, e
...
it may be difficult to find
relevant skilled labour to increase output
...
With agricultural products, supply is inelastic in the short run because
it takes at least 6 months to grow crops
...
•
Perfectly elastic supply means that at a given price, supply is unlimited
...
% change in Q = 10/50 = 20%
% change in price = 3/60 = 5%
Therefore PES = 20/5 = 4
...
If there are stocks available
...
Difference between long run and short run
• In the short run, supply is more likely to be inelastic because the firm
does not have the ability to increase the size of the factory
...
Elasticity calculation
Suppose PES for computers is 2
...
When the price was £30, the firm supplied
4,000
...
Therefore as a %, (6/30 =0
...
0 = % change in QS
20 (% change in P)
Therefore 40 = % change in QS
Therefore new Q = 4000 *140/100 = 5,600
Market equilibrium
The price mechanism refers to how supply and demand interact to set the
market price and the amount of goods sold
...
Excess demand
If the price is below equilibrium (p2), demand is greater than supply (Q2 – Q1) –
causing a shortage
...
Prices will rise until supply equals demand
...
To sell the unsold goods, firms reduce the price and reduce supply
(movement along supply curve)
...
The price falls to P1 where supply equals demand
...
Initially there would be a shortage, but the higher demand would cause
the price to rise and suppliers to supply more
...
In the long-‐term, the higher prices may encourage more firms to enter the
market and the supply curve will shift to the right
...
•
•
The fall in the supply of oil causes the price to rise and a small fall in
demand
...
Impact in long term
•
•
If the price of oil increased, it may start to make it profitable to produce
oil from new places, such as Alaska and Antarctic
...
If the price of oil rises, in the long-‐term people may respond to higher
prices by switching to other forms of transport or cars which don’t use
petrol
...
•
The price of a good, such as coffee, would fall if there was a fall in demand
and/or an increase in supply
...
• Coffee becomes less fashionable
...
• A fall in number of coffee shops
...
The supply of coffee could increase for various reasons such as:
• An increase in the number of suppliers or countries producing coffee
...
g
...
• Government subsidies, e
...
Latin American countries may wish to
subsidies the coffee farmers
...
Price mechanism
The price mechanism refers to how market forces respond to changes in supply
and demand
...
The higher price causes movement along the demand curve
...
This helps to ration the scarce demand
...
This higher price makes the good more profitable
...
In the long term, firms respond to higher prices by increasing supply
...
• If we see higher demand, prices will rise and this creates a signal to
producers that there is high demand
...
Consumer and producer surplus
•
•
Consumer surplus is the difference between the price that consumers pay
and the price that they would be willing to pay
...
•
•
•
Consumer surplus tends to be higher when markets are competitive and
prices are low
...
Peak fares are an attempt to charge higher prices to those commuters
willing to pay the higher price
...
If the market price is £10, and their supply curve shows that they would
have supplied it at £8, they have a producer surplus of £2
...
In this case, we see a decline in consumer surplus
...
In the case of a monopoly, firms are able to charge consumers a higher price;
this reduces consumer surplus and increases producer surplus
...
Tax
Tax increases the cost of the good and shifts the supply curve to the left
...
The tax increases the price from £50 to £80
...
The total tax revenue for the government will be: 82 × £35 = £2870
The burden of tax
The burden of the tax is shared between consumers and producers
...
Producers also lose out from tax because they get a lower price after
paying tax to the government
...
In the diagram on the right, demand is price elastic and there is a
proportionally smaller effect on price and consumers
...
Consumer burden is relatively less
...
Often tobacco
manufacturers will be able to pass 100% of the tax increase onto
consumers because demand is so inelastic
...
For every
good sold, the government will give firms a proportion of the cost
...
The subsidy increases Q from 90 to 98
...
Why subsidise goods?
1
...
For example, taking the train to work helps reduce congestion
...
2
...
g
...
The impact of a subsidy depends on elasticity of demand
...
If demand is price inelastic (left) there is a bigger percentage fall in price
...
1
...
10 Alternative views of consumer behaviour
We assume consumers are rational – seeking to maximise their utility
...
•
•
•
•
•
Consumers may buy out of habit
...
g
...
Consumers tend to be poor at working out which goods are cheaper
...
Consumers are heavily influenced by advertising
...
Market Failure
Market failure occurs when there is an inefficient allocation of resources in a free
market
...
•
•
•
•
•
Externalities – a cost or benefit imposed on a third party, leading to
under-‐ or over-‐consumption
...
E
...
people may under-‐estimate the benefits of education (merit good) or
underestimate the costs of smoking (demerit good)
...
Monopolies may also be more inefficient because they face less
competitive pressures
...
E
...
unemployed coal miners in
Yorkshire find it difficult to move to London because of housing costs
...
Public goods – Goods that are non-‐rival and non-‐excludable
...
Examples include
law and order, national defence and street lighting
...
Social benefit = private benefit + external benefits
...
SMB = PMB (private marginal benefit) + XMB (external marginal benefit)
Social cost
•
•
•
Social cost is the total cost to society
...
Social marginal cost (SMC) = private marginal cost (PMC) + external
marginal cost (XMC)
Negative externality
A negative externality occurs when there is a cost imposed on a third party
...
If you drive into a town centre, the negative externality is the congestion
and pollution that affects other people in the town
...
In a free market, the equilibrium will be at Q1, P1, where Supply (S) = Demand
(D)
...
Q1 is socially inefficient because the SMC is greater than the SMB – this
illustrates an area of deadweight welfare loss
...
The socially efficient level of output would be at Q2, where SMC=SMB
...
•
•
For example, if you cycle to work (rather than drive), other people benefit
from reduced congestion and pollution
...
Diagram of positive externality
In a free market, the equilibrium will be at Q1, P1, where Supply (S) = Demand
(D)
...
At Q1, the SMB is greater than the SMC, leading to an area of deadweight
welfare loss
...
Social efficiency occurs at Q2, where SMB=SMC
...
•
The private good is rivalrous and excludable
...
Public good
A public good, by contrast, has two characteristics:
•
•
Non-‐rivalry
...
g
...
Non-‐ excludability
...
g
...
Public goods suffer from the free-‐rider problem
...
Therefore, there is no incentive for firms to provide goods
because it is difficult to charge consumers for using it
...
• Public goods usually require the government to provide the good directly
and pay for it out of general taxation
...
Some goods have part of the characteristics of public goods, e
...
g
...
Some people are not qualified to drive
...
E
...
Someone may
provide a beautiful garden and not mind if people enjoy it for free
...
For example, the NHS is provided by the public sector (government)
...
If you see a doctor, no one else can
...
Information gaps
•
•
Symmetric information means both parties share the same knowledge
...
Asymmetric information occurs when one party has more information
than other parties
...
But, as a consumer, you may not know this
...
This leads to lower prices for all second hand cars
...
Merit good
A merit good occurs where people may underestimate or be unaware of the
benefits of consuming a good
...
Or people may be reluctant to get a
vaccination from diseases
...
Merit goods are under-‐consumed in a free market
...
•
•
•
For example, people may not be aware of the dangers of smoking
...
g
...
Demerit goods are over-‐consumed in a free market
...
Tax
•
•
Tax shifts the supply curve to the left and makes the good more expensive
...
The government can use tax for demerit goods and goods with negative
externalities
...
It is the same whatever
the price, for example, tobacco duty or alcohol excise duty
...
The
price rises from £52 to £60
...
For example, VAT in
the UK is 20%
...
Tax to overcome market failure
•
•
•
The Ideal tax would be equal to the external marginal cost
...
Tax shifts the supply curve to S2 and reduces demand to Q2, which is the
socially efficient level (SMC=SMB)
...
Internalises the externality (tax makes people pay the full social cost)
...
Tax can also alter consumer behaviour in the long-‐term
...
Evaluation of taxes
•
•
•
•
•
If demand is very inelastic, tax will only have a minimal effect in reducing
demand
...
g
...
High taxes may encourage tax evasion, e
...
cigarette tax encourages
cigarettes to be smuggled on the black market
...
High specific taxes will be regressive
...
There may be administration costs in implementing new taxes, e
...
it
would be difficult to implement a congestion charge for driving into small
cities, like Oxford or Cambridge
...
Subsidy
•
•
The aim of subsidies is to encourage consumption of goods which are
underprovided / under-‐consumed in a free market
...
Subsidy to overcome market failure
•
•
In this example, the free market equilibrium is at Q1, P1 (S=D)
...
At this price, the quantity demanded is Q2
...
Evaluation of subsidies
•
•
•
•
•
Cost to the government
...
Elasticity
...
For example, a subsidy on train travel may be
ineffective if it is a poor substitute to driving a car
...
A firm that receives a subsidy is more likely to
be inefficient, as they become reliant on the government subsidy
...
There may be government failure, e
...
the government has poor
information about who to subsidise
...
Subsidies may be most effective if combined
with other policies, e
...
tax on driving and using money to provide
alternatives to driving into town, e
...
cheaper buses
...
For example, if renting a house in London is £120 a week, the government may
decide to have a maximum price of renting of £100 a week to make housing more
affordable
...
At Max Price, demand is greater than supply (Q3-‐Q1)
...
•
•
The extent of the shortage depends on the elasticity of demand and
supply
...
Note: if the maximum price was placed above the equilibrium, it would
have no effect
...
With minimum prices, the government may be committed to buying the surplus
...
At Min price, supply is
greater than demand (Q3-‐Q1)
...
•
Note: a minimum price below the equilibrium would have no effect
...
g
...
•
•
•
•
If the firm produces less pollution, it can sell its permits to other firms
...
There will be a market for pollution permits
...
Therefore, there is a financial incentive for firms to cut pollution
...
It may be difficult to accurately measure pollution levels
...
In most markets, it requires global co-‐operation to make it effective,
otherwise the industry will move to countries with lower environmental
legislation
...
•
High administration costs of measuring pollution and enforcing permits
...
For example, the government could subsidise private doctors to treat people, but
there are advantages to the government paying for a national health service
directly:
•
•
•
•
It ensures everyone has access to this important merit good and provides
greater equality in society
...
For services like health and education, workers do not need the same
profit motive of a private manufacturing firm
...
Public goods like law and order may not be provided at all in a free
market
...
g
...
Increased demands are being placed on the public sector due to
demographic changes
...
2
...
3
...
4
...
g
...
5
...
Disadvantages of the private sector
1
...
Also, the private sector may cut costs by reducing
the quality of service, e
...
cutting back on cleaning
...
May increase inequality
...
3
...
Therefore there is a justification for government subsidy
...
•
•
For example, the government may run campaigns to warn about the
health dangers of tobacco and alcohol
...
Providing information can help overcome information asymmetries
...
There is no guarantee people will listen or take note of government
campaigns
...
However, over time, people have become aware of the dangers of tobacco
and long-‐term smoking rates have been falling
...
•
•
For example, rather than try and tax cocaine to make people pay the full
social cost, they may just prohibit its production and consumption
...
Evaluation
•
•
Regulation is simple and can be effective in preventing damaging goods
and services from being produced
...
Cars create negative
externalities, but it is not desirable to ban cars completely
...
For example, when the US prohibited
alcohol, it was very hard to enforce
...
Government failure
Government failure occurs when government intervention in the economy
causes a net welfare loss
...
Causes of government failure
1
...
Government bodies do not
have the same profit motives of private companies
...
The result can be
government agencies that are inefficient, with higher costs and not producing
what people need
...
Incentives may be less important in services like health care, where
doctors value patient health
...
Unintended consequences
...
For example:
•
•
•
•
Minimum prices in agriculture were an attempt to stabilise farmers’
incomes
...
Farmers used chemicals to
maximise yields – knowing the government would buy any surplus
...
By increasing taxes on tobacco, the government made it more
profitable for people to smuggle cigarettes from Europe
...
Higher income tax may discourage people from working
...
Lack of information
...
•
•
For example, it can be difficult for a government body to calculate the net
external costs of a new airport or nuclear power
...
g
...
4
...
Any government intervention is likely to have some
administration costs and bureaucracy
...
With some new taxes, the cost of bureaucracy may be close to the
revenue gained
...
GDP also measures national income / national
expenditure
...
Real GDP measures GDP adjusted for effects of inflation
...
GDP per capita is the level of GDP divided by population
...
g
...
The volume of goods and services is the quantity produced
...
Economic growth means an increase in real GDP, referring to an increase
in the total value of goods and services produced in an economy
...
E
...
in Q2 2014,
economic growth was 0
...
(this is roughly an annual rate of 2
...
In 2008/09, economic growth was negative – Real GDP was falling
...
For example in the UK, this is
about 2
...
This shows the growth in real GDP compared to the trend rate of growth
...
Long term economic growth
UK economic growth since 1949
...
Other measures of national income
Gross National Product (GNP) GNP = GDP + Net property income from abroad
...
•
GNP includes the value of all goods and services produced by nationals
whether in the country or not
...
Gross national income (GNI) is based on a similar principle to GNP
...
It also includes interest payments and
dividends from citizens living in other countries
...
It shows
how closely economies are tied together
...
Post 2010, Italy’s economic recovery has lagged behind that of other
countries
...
It is a better guide to actual living standards and a reflection of the value
of goods and services that people can buy in the economy
...
If you spend $10 in the US, you may be able to buy one meal
...
But, with
this 600 Rupees you can purchase two meals
...
Big Mac Index
The Big Mac index, published by the Economist magazine, offers a rough
illustration of this
...
In
theory, the ingredients are the same, so a difference in price reflects different
exchange rates
...
50 in South Africa to $4
...
When making comparisons of living standards, we need to bear this in
mind
...
•
•
•
•
•
Defensive spending
...
g
...
External costs of GDP
...
For example, China’s recent growth has been very high, but pollution is
now a serious problem
...
If a country spent 40% of GDP on
military spending, this would have a very different impact on living
standards than spending the same money on education and health care
...
Real GDP per capita may be high, but if 90% of
the country’s wealth is owned by just 1% of the population, then many
people may be in poverty and have low living standards
...
Hours worked
...
•
Living standards depends on many factors other than GDP
...
Evaluation
•
Although there are limitations to using GDP, don’t forget that it is a good
starting point
...
Higher GDP enables better public services, such as health and
education
...
National Happiness
The UK now publishes a measure of ‘National well being’
...
•
•
•
•
•
The index includes positive statements, e
...
unemployment rate, voting
rates, crime rates
...
g
...
The index measures how these index tools change over time, e
...
the
overall index of national wellbeing would rise if more people responded
positively to questions about personal wellbeing
...
It is an attempt to move away from relying on purely financial indicators,
such as GDP – which on their own may not increase wellbeing
...
People’s perceptions of satisfaction may change
due to unexpected factors
...
Surveys could be influenced by temporary factors, such as an early World
Cup exit for the national team
...
Inflation
•
•
•
Inflation
...
If
there is inflation, the value of money declines and there is an increase in
the cost of living
...
This means there is a fall in the price level (negative inflation
rate)
...
This means there is a falling inflation rate – prices are
increasing at a slower rate
...
This is calculated through different steps
...
Household expenditure survey
...
From this we get a typical basket of the most
popular 1000 goods and services
...
Weighting of different goods
...
For example, petrol may have a weighting of 5% of the
total basket of goods
...
4%
3
...
Every month, changes in the prices of goods and services
are measured
...
Problems with calculating CPI
•
•
•
•
The expenditure survey does not include everybody e
...
pensioners are
excluded, but pensioners have different spending habits e
...
heating is
more important
...
Changes in quality: Computers have many more features than 10 years
ago, so it is difficult to compare prices because they are different goods
...
It is impossible to measure all prices in the economy
...
It is similar to CPI, but includes
more factors
...
This can make RPI
more volatile, e
...
if interest rates rise, we will see RPI inflation increase
more than CPI because mortgages are more expensive
...
On consumers
•
•
•
Fall in value of savings
...
If inflation is higher than interest rates,
savings will decrease in value
...
High inflation will reduce the value of debt, making
it easier for consumers and firms to pay back their debt
...
Fall in real wages
...
If
inflation is higher than nominal wage growth, real wages will fall
...
•
•
Between 2001 and 2008, wages grew at a faster rate than CPI inflation
...
Since 2008, wages have been mostly growing at a slower rate than
inflation
...
Exam tip – Inflation doesn’t mean people automatically buy less
...
•
However, inflation could cause less spending if prices are rising faster
than wages
...
High inflation may create uncertainty and confusion for
firms
...
Less
investment can reduce the rate of economic growth
...
High inflation can create menu costs, which means firms
have to adjust price lists
...
Effect of inflation on economy
•
•
•
Less investment
...
It is argued that
periods of low inflation are beneficial for promoting investment and
sustainable economic growth
...
Relatively higher inflation in the UK can
make UK firms less competitive, leading to lower exports and
deterioration in the current account (or depreciation in the exchange
rate)
...
Governments may be concerned about inflation
because of the uncertainty and potential for declining living standards
...
Higher interest rates can reduce inflation, but at the cost of
lower economic growth – and a boom and bust economy
...
1
...
2
...
Causes of inflation
1
...
Demand pull inflation occurs if economic growth is too fast – i
...
if growth
is above the long run trend rate
...
Demand
pull inflation could occur due to various factors
...
A cut in interest rates reduces the cost of borrowing
– encouraging spending and investment
...
Boom in exports from rising global demand
...
•
•
•
•
The UK’s last period of demand pull inflation was the late 1980s
...
Inflation was close to the government’s target of 2% between 1992 and
2008
...
Inflation did not increase until 2008, when it reached over 5%
...
2
...
Cost push inflation could occur due to:
•
•
•
Rising oil prices / raw material prices
...
Rising wages
...
(Rising wages may also
cause demand-‐pull inflation as consumers spend more increasing AD
...
One third of all goods are imported in the UK
...
Effect of a devaluation in the exchange rate on inflation
If the exchange rate falls in value, it tends to cause inflation for three reasons
...
Higher AD
...
More expensive
imports reduce import spending and encourage consumers to buy from
UK firms
...
2
...
Many goods are imported; after a
devaluation, they will be more expensive
...
Less incentive to cut costs
...
Cost push inflation in UK 2008 – 2011
•
•
In 2008, the UK had a cost push inflation of 5%
...
In 2011, the UK had more of a cost push inflation of 5% -‐ despite a lengthy
recession
...
3
...
The money supply could grow if the Central Bank printed more money
...
In a boom, the money stock changes hands more frequently, and this can
cause inflation
...
For example, if the
Central Bank printed more money, it would generally cause more
inflation – though the link between the money supply and inflation may
not happen in a recession
...
Under-‐employment occurs when someone is working part-‐time (e
...
on a zero
hour contract), but would prefer to work full-‐time
...
This occurs when people are not in the labour force
...
They could include categories, such as
early retirement, disillusioned long-‐term unemployed, long-‐term sick, disabled,
etc
...
More difficulty getting work in the future, as the unemployed lose ‘on-‐the-‐
job skills’ and may become less attractive to future employers
...
Increased government borrowing
...
Lower GDP for the economy and possible negative multiplier effect
...
Claimant count method
...
It counts the number of people receiving benefits (Job Seekers
Allowance)
...
It
excludes people over 60 / under 18, people on government training
schemes, and married women looking to return to work
...
Some people may claim benefits whilst still working in the “black market”
...
The Labour Force Survey
This was a survey asking 60,000 people whether they are unemployed and
whether they are looking for a job
...
•
UK unemployment % since 1992
...
Frictional unemployment
...
g
...
There will always be some
frictional unemployment as it takes time to find a job
...
Structural unemployment
...
It can be caused by:
•
•
Occupational immobilities
...
g
...
Geographical immobilities
...
g
...
We often see
higher unemployment in depressed regions
...
Classical or Real Wage Unemployment
...
This could be
caused by minimum wages or trades unions
...
Demand deficient or ‘cyclical unemployment
...
If there is less demand for
goods, firms will employ less workers
...
The fall in AD, leads to a decline in real GDP
...
Unemployment peaked in 1983, 1993 and 2012 – these were after recessions
...
Voluntary unemployment
...
Policies to reduce unemployment
1
...
Or the Bank of England could
cut interest rates to reduce the cost of borrowing and encourage spending
...
•
However, demand side policies may cause higher rates of inflation and
will not reduce supply side unemployment, like structural unemployment
...
Education and training
...
This gives a
better opportunity for the unemployed to find work in new industries
...
3
...
This could help reduce
frictional unemployment by giving the unemployed better information about
available job vacancies, and also offering tips for the unemployed to get work
...
Lower benefits and taxes
...
This
could reduce frictional unemployment
...
5
...
If the minimum wage is above the equilibrium,
reducing it to the equilibrium will enable firms to employ more workers, which
reduces real wage unemployment
...
6
...
These can help overcome geographical unemployment by
encouraging firms to set up in depressed areas or helping workers to move to
areas of high demand
...
Firms may
have a similar reluctance to set up in depressed areas because of a lack of
infrastructure
...
Impact of net migration to the UK
•
•
•
•
Increase in the supply of labour
...
g
...
Skilled labour
...
This has meant migration has played an
important role in filling vacancies such as nurses and doctors
...
The UK has an aging population
that places greater strain on government finances
...
In periods of rising unemployment, migrants often return home
...
Problems of net migration
•
•
•
UK experiences overcrowding especially in areas like London; migration
and the rise in population places strain on housing and public amenities
...
Some may feel migrants take existing jobs
...
The balance of payments
The balance of payments is a record of a country’s transactions with the rest of
the world
...
Current account
The current account is primarily concerned with the balance of trade in goods
and services
...
Trade in goods (visibles) e
...
cars, computers, food
2
...
g
...
Net income flows (interest, dividends and investment income from
abroad)
4
...
g
...
• A deterioration in the current account means that we get a bigger deficit
or we go from a surplus to a deficit
...
It includes financial
flows (e
...
saving in banks) and net investment (e
...
foreign firm’s building
factory in the UK)
...
Factors that cause a current account deficit
1
...
If the currency is overvalued, imports will be
cheaper and therefore there will be a higher quantity of imports
...
2
...
If there is an increase in real wages, people will have more
disposable income to consume goods
...
Consumer-‐led
growth often causes a deterioration in the UK current account
...
Inflation / decline in competitiveness
...
•
A decline in competitiveness could be caused by factors such as poor
infrastructure, higher wages and lower productivity
...
Devaluation
...
This should increase
the quantity of exports and reduce imports
...
However, it does depend upon the elasticity of demand for exports and imports
...
•
•
A problem with devaluation is that it can lead to imported inflation
...
Also, in a floating exchange rate, the UK government does not set the
exchange rate; therefore, they would need to rely on a market
depreciation in the exchange rate
...
Reduce consumer spending
...
Lower consumer spending will lead to less spending on imports,
improving the current account
...
Deflationary policies will also put pressure on manufacturers to reduce
costs; this will lead to more competitive exports, and so exports will
increase
...
With lower AD, economic growth is likely to fall, causing higher
unemployment
...
3
...
These are policies aimed at increasing productivity and
competitiveness
...
For example, the government could try to deregulate
labour markets to reduce wage costs and lower costs for exporters
...
g
...
Also, there is no guarantee that more
flexible labour markets would improve competitiveness because lower
wages may reduce worker morale
...
Effect of a current account deficit in the UK
If the UK has a current account deficit, it has the following effects
...
Lower AD
...
•
•
On the other hand, a current account deficit may occur due to high levels
of consumer spending and economic growth
...
A UK current account deficit could be due to low economic growth in
Europe
...
2
...
A current account deficit could cause a depreciation in the
value of the exchange rate because we are buying imports and therefore buying
foreign currency
...
3
...
A current account deficit requires flows of capital to finance the
deficit
...
g
...
g
...
•
If we have a foreign investment in the UK, e
...
building a factory, this
could have a benefit to the economy
...
Aggregate demand
Aggregate demand (AD) is the total demand for goods and services in the
economy
...
g
...
•
•
•
At a higher price level, ceteris paribus, consumers have less disposable
income (money to spend)
...
A shift in the AD curve would occur if there was a change in factors like
real income; higher income would shift AD to the right
...
Shift in AD
•
•
If there was an increase in income, the AD curve would shift to the right
(AD2)
...
Consumer spending (C)
Consumer spending is the biggest component of AD (approx
...
Consumer spending is determined by:
•
•
•
•
•
•
•
Disposable income
...
Rising real
wages would increase disposable income and shift AD to the right
...
The alternative to spending disposable income is to save
...
Consumer confidence
...
Low confidence will shift AD to the left
...
House prices / wealth
...
In the UK, many people own
their houses
...
They will also feel more
confident if their house is worth more
...
A cut to income tax will increase consumers’
disposable income, encouraging spending
...
Lower interest rates reduce the cost of borrowing
encouraging spending
...
Cost of living
...
g
...
(This factor causes movement along the AD curve)
2
...
3 Investment
Investment means expenditure on capital goods – factors that increase the
productive capacity of the economy, e
...
machines and factories
...
Investment affects both AD and AS
...
Factors that affect investment
•
•
•
•
•
•
Confidence
...
If
businesses face uncertainty, they will cut back on risky investment
...
Keynes said investment was heavily influenced by the
‘animal spirits’ of businessmen – did people expect their business to
grow? This confidence can quickly change depending on the state of the
economy
...
Investment is often financed by borrowing or using
savings
...
Availability of finance
...
Banks may be reluctant to give a small
business a loan because it is a risky investment
...
Government regulation
...
g
...
On the other hand,
governments could encourage investment through offering regional
subsidies
...
A key factor in determining investment is the rate of
economic growth
...
Also important is the demand from overseas and the
demand for exports
...
g
...
In 2013/14, the UK
government spent a total of £722
...
Government spending
is influenced by:
•
•
•
Fiscal policy
...
g
...
Economic cycle
...
Political cycle
...
Net Trade (X-‐M)
The UK’s main trading partner is the EU (60% of trade)
...
Factors that affect (X-‐M)
•
•
•
•
•
Exchange rates
...
This will tend to increase (X-‐
M) and increase AD
...
If UK growth is relatively higher than other countries,
we will see a rise in import spending and this will reduce net (X-‐M)
...
Competitiveness
...
Improved
competitiveness could be due to lower wages or higher productivity
...
In addition to price, the quality and desirability of UK
goods and services will be important
...
Tariffs and protectionist measures
...
For example, if the UK left the EU, it
may find that there are higher costs / tariffs on exports to Europe
...
It is the
sum of all the individual supply curves for particular goods
...
•
•
In the diagram on the left, the AS curve has shifted to the left, leading to
a higher price and lower real GDP
...
This causes a higher
price level (P1 to P2) and movement along the AS curve
...
For example, firms can pay workers to do overtime
...
In the long run, AS is determined by the stock of capital and quantity of labour,
etc
...
In the long run, AS is determined by factors of production – land, labour,
capital
...
These include
•
•
•
The price of raw materials, e
...
oil, metals, food, gas and electricity
...
Devaluation would increase the cost of many imported
raw materials, such as oil
...
A rise in VAT or excise duty would increase the cost
and shift the SRAS to the left
...
This causes SRAS to shift to the left
...
A fall in the prices of raw materials would have the opposite effect -‐ SRAS
would shift to the right
...
(Labour productivity means output per worker
...
A rise in the number of working age people will increase the
labour force and increase productive capacity
...
The UK
labour force has increased due to net migration in the past decade
...
Technological improvements are one of the biggest factors
affecting labour productivity, e
...
the Internet makes it easier for firms to
check costs and prices
...
If firms or the government invest in increasing the capital
stock, we will see higher AS in the long run
Education and skills
...
Infrastructure
...
•
•
Government policies
...
For example,
privatisation and deregulation may increase efficiency and competitive
pressure in industries like gas and electricity
...
Most technological improvements come from
the private sector
...
A stable economic and political climate may
encourage entrepreneurs to invest and develop business
...
•
•
On the left, the classical view is that LRAS is inelastic
...
Economic growth requires LRAS to
shift to the right
...
g
...
Which AS curve to draw?
•
•
•
•
Many students ask, which curve should I draw? We have SRAS and two
LRAS
...
However, it can be important to distinguish between SRAS and LRAS
...
Capital investment would affect LRAS
...
National Income
The circular flow of income shows how money flows from households to firms
(to buy goods)
...
The circular flow of income shows three ways to calculate GDP (Gross Domestic
Product)
...
Total national income (wages, dividends,)
2
...
Total national output (value of goods and services produced)
Income and wealth
•
•
Income is a flow concept
...
g
...
Wealth is a stock concept
...
g
...
g
...
Injections
This is an increase of expenditure into the circular flow of income, leading to an
increase in aggregate demand (AD)
...
Exports (X) – spending from abroad on domestic goods
...
Government spending (G)
...
Investment (I) -‐ spending on capital goods by firms
...
Withdrawals can
include:
•
•
•
Saving (S) – depositing money in banks
...
Taxation (T) – the Government raising money from consumers and firms
...
•
In this example, there is a fall in AD, leading to a change in equilibrium
national income
...
Increase in AD
Suppose that we have an increase in injections into the circular flow
...
This will lead to higher AD and higher real GDP
...
For example, if the government increased G (government spending) by £10
billion, and this led to an increase in real GDP of £16bn, we say the multiplier
effect is 16/10 = 1
...
If the government spends £10bn on building roads,
they will employ workers
...
But, the unemployed will now have extra money to spend
...
•
In other words, the initial spending doesn’t just stay with one person
...
Higher spending leads to more income for
others, and therefore further rounds of spending
...
But, because of the
multiplier effect and further rounds in spending, we get another increase in AD
to AD3 -‐ causing a bigger final increase in real GDP
...
E
...
if confidence is high, the MPC will be higher
...
g
...
Higher interest rates may encourage more
saving
...
This is determined by income tax rates and VAT rates
...
Marginal propensity to withdraw (MPW) = MPS+MPT+MPM
...
•
•
•
The higher the marginal propensity to consume, the bigger the multiplier
...
If consumers have a high marginal propensity to withdraw, then the
multiplier effect will be low
...
If the government increased spending by £20bn (financed by borrowing), and:
•
•
•
MPS = 0
...
15
MPT = 0
...
75
...
25
...
The multiplier effect = 1/0
...
33
2
...
33 = £26
...
If the
economy is close to full capacity, rising demand may just lead to inflation
...
Economic Growth
•
•
Economic growth means an increase in real GDP
...
The rate of economic growth measures the annual % change in real GDP
...
A quarterly growth rate of 0
...
0%
...
The long run trend rate of economic growth is the sustainable rate of
economic growth in an economy
...
5%
...
This graph shows that in the recession of 2008-‐12, UK real GDP growth fell
behind the trend rate of economic growth
...
Causes of economic growth
1
...
If there is spare capacity in the economy, then a rise in AD will
lead to higher real GDP
...
Rising house price – leading to a positive wealth effect, encouraging
consumer spending
...
Higher confidence in the economy – encouraging spending and
investment
...
Increase in LRAS (supply side factors)
This diagram shows economic growth in the long run, with an increase in LRAS
and AD
...
Better education and training to increase labour productivity
...
(See factors affecting AS for more
...
In the
real world, the rate of economic growth is rarely constant
...
Positive output gap
•
A positive output gap will occur when actual economic growth is above
the sustainable potential
...
g
...
5%, but we
have growth of 4
...
They have increased output in the short run (e
...
getting
workers to do overtime)
...
A positive output gap occurs when AD increases faster than AS
...
Lower unemployment as there is greater demand for workers
...
The Central Bank may deal with the inflation by putting up interest rates
...
Negative output gap
A negative output gap occurs when economic growth is below the sustainable
potential, e
...
it could be due to very low economic growth at 0
...
2%)
...
This will be
due to low aggregate demand
...
We can see high periods of economic growth, followed by
periods of low economic growth
...
It is characterised by:
•
•
•
•
High rates of economic growth
Higher inflation
A deterioration in the current account
Lower unemployment
A boom could be caused by very high confidence or an increase in high prices
...
Also, consumers may run out of money to spend; there is only
so much you can borrow, and there may come a time when high confidence turns
to pessimism
...
This graph shows that the EU economy was in recession 2008/09 and 2012/13
...
Real incomes will fall, reducing living standards
...
Unemployment tends to rise
...
Also, with lower demand, firms
will have less demand for workers
...
Higher government borrowing
...
g
...
Also, the government will need to spend
more on benefits, such as unemployment benefits
...
Fall in asset prices, such as houses
...
2
...
4
...
Higher incomes
...
With higher output, firms will employ more
workers
...
Lower government borrowing
...
e
...
Also, there is
less need to spend money on unemployment benefits
...
With higher tax receipts, more can be spent on
health care, infrastructure and education
...
Firms will make higher profits; this may
encourage more investment, which can lead to a virtuous circle of higher
growth
...
Inflation
...
•
•
If economic growth is unsustainable (i
...
it occurs too fast), it causes a
positive output gap and inflation
...
2
...
If economic growth is unsustainable, then
high inflationary growth may be followed by a recession
...
3
...
Higher consumer spending causes an increase
in imports, causing a deficit on the current account
...
4
...
Increased economic growth will lead to increased
output, and therefore will cause increased pollution and congestion, which
reduces living standards
...
However, higher growth may enable
more resources to be spent on the environment
...
Increased inequality
...
However, this depends upon things such as tax rates and
the nature of economic growth
Macro economic objectives
The primary economic objectives of a government are likely to be:
1
...
Most governments would try to maximise sustainable
economic growth to increase living standards and help create
employment
...
Low inflation
...
The government wishes to both avoid high inflation and also the threat
of deflation
...
Low unemployment
...
Full employment would be an unemployment rate of around 3% (there is
always some frictional unemployment)
...
Satisfactory current account / balance of payments
...
g
...
Therefore, governments may
wish to have a reasonable low deficit/surplus,
5
...
Governments often commit to fiscal
targets for both annual borrowing, and total debt (public sector net debt)
...
Stable exchange rate
...
Therefore, governments may
prefer a stable exchange rate (e
...
a fixed exchange rate system)
...
High economic growth may be at the expense of
income inequality
...
Environment
...
Looking after
environment may require some sacrifice in terms of economic growth
...
g
...
Demand side policies
Demand side policies involve attempts to influence AD
...
Fiscal policy – the government changing levels of spending (G) and taxes
(T)
...
Monetary policy – Changing interest rates
...
Fiscal policy
Fiscal policy is the governments attempt to influence AD
...
Stimulate economic growth in a period of a recession
2
...
This involves lower tax rates and/or higher government spending, with the aim
to increase AD
...
It may cause inflation
...
The aim of deflationary fiscal policy is to decrease AD and inflation
...
Evaluation of fiscal policy
1
...
Therefore, the government may be unsure
whether they need to boost AD or reduce AD
...
But, in major
recession, they may try expansionary fiscal policy
...
It depends on other components of AD
...
3
...
Higher income tax to reduce inflation can create
disincentives to work, reducing productivity and AS
...
Time lag involved in influencing AD
...
But, there
will be delays in actually implementing higher spending, and then delays
in this spending affecting the wider economy
...
Budget deficits
...
This could lead to higher interest
rates in the long term or even cause markets to lose confidence in debt
levels
...
Crowding out
...
Public Sector Net Debt PSND (The National Debt)
This is the total (cumulative) amount of debt that the government owes the
private sector
...
3 billion, equating to 80% of GDP
...
It fell during the post war period as economic growth led to higher
GDP – making debt a smaller percentage
...
The budget deficit will be the difference between government spending
(G) and tax revenue
...
This shows public sector net borrowing (budget deficit) in the UK
...
Government
spending was less than tax revenues
...
In the recession, tax receipts fell and spending on
unemployment benefits rose
...
The budget deficit is measured through stats, such as Public Sector Net Cash
Requirement (PSNCR) and net borrowing
...
The two main
types of taxation are:
1
...
These taxes are taken
directly from a person’s wages
...
2
...
Consumers pay these taxes
indirectly; when a good is bought, the firm has to pay the VAT rate to the
government (20%)
...
g
...
Monetary Policy
Monetary policy involves changing the interest rate or manipulation of the
money supply by the monetary authorities
...
Aims of monetary policy
1
...
Inflation target for MPC is CPI -‐ 2
...
Maintain sustainable economic growth
3
...
If they feel the
inflation rate is likely to go above the target (e
...
due to a higher rate of
economic growth) then they will increase interest rates to moderate
demand and keep inflation low
...
To determine future inflation, the MPC will look at various statistics such as:
•
•
•
•
The rate of economic growth compared to the long run trend rate
...
Wage growth
...
Temporary factors like tax rises and commodity price rises will be given
less importance because they do not indicate underlying inflation
...
High unemployment will tend to reduce wage inflation
and so the MPC is more likely to cut interest rates to boost AD
...
This will help reduce AD and inflation because higher
interest rates:
•
•
•
•
•
Makes borrowing more expensive, therefore people spend less on credit
...
The cost of mortgages increases, therefore people have less disposable
income causing a fall in consumption
...
Saving money in a bank is more attractive therefore there is less spending
and relatively more saving
...
Evaluation of monetary policy
1
...
If the
economy is close to full employment, a cut in interest rates is likely to just cause
inflation significantly with only a small increase in real GDP
...
g
...
2
...
The effectiveness of monetary policy
depends upon other variables in the economy, for example:
•
•
•
If confidence is low, a reduction in interest rates may not increase
demand
...
If the world economy is slowing, this will reduce exports and AD; this
would keep spending low -‐ even if there was a reduction in interest rates
...
Time lags
...
E
...
higher interest rates may not reduce investment in the short term because
firms will continue with existing investment projects
...
Conflicts of objectives
...
If the MPC reduces inflation, this may lead to lower growth
or higher unemployment
...
This was due to:
•
•
•
•
•
Banking crisis that led to banks cutting back on lending
...
Fall in investment and consumer confidence due to the banking crisis
...
Decline in exports, due to the global economic downturn
...
Responses to great recession
•
•
•
•
In the UK, interest rates were cut from 5% to 0
...
5%)
...
Quantitative easing was tried from 2009
...
The aim was to increase spending and
bank lending through increasing the money supply and also reducing
interest rates on government bonds
...
From 2010, the new coalition government pursued austerity measures
(spending cuts) designed to reduce the budget deficit
...
Other economists argue that there were many factors
causing slow growth in the UK, such as the recession in Europe
...
The UK economy recovered in 2013/14, with positive growth and falling
unemployment
...
Supply side
policies can be either:
1
...
g
...
2
...
g
...
Supply side policies can help the economy in various ways:
1
...
Shifting AS to the right will cause a lower price level
...
Lower unemployment
...
3
...
Supply side policies will increase economic
growth by increasing AS
4
...
By making firms more
competitive, they will be able to export more
...
Privatisation
...
It is argued that the private sector is more efficient in running
businesses because they have a profit motive to reduce costs and develop
better services
...
Deregulation
...
Greater competition creates incentives to
reduce prices and costs
...
3
...
It is argued that lower taxes (income and corporation)
increase incentives for people to work harder, leading to higher output
...
Reducing state welfare benefits
...
Reduced bureaucracy for firms
...
6
...
Some economists argue that many European
labour markets are too heavily regulated
...
On the
downside, greater labour market flexibility may lead to greater job
insecurity for workers
...
Better education can improve labour
productivity and increase AS
...
Therefore, the
government may need to subsidise suitable training schemes
...
Improving transport and infrastructure
...
If transport networks
were improved, firms would benefit from lower costs
...
g
...
It will cost money to improve information and education, and therefore
taxes will need to rise
...
Government failure may occur
...
For example, the
government may finance the wrong kind of scheme, such as a new train
line that is not used very much
...
In a recession the most
important thing is not supply side policies but policies to increase
aggregate demand
...
In this situation, the economy needs
an increase in AD (demand side policies)
...
It is important to bear in
mind that technological improvements and productivity gains come
largely from the private sector
...
At best, the government can create a climate for private
sector innovation to occur
...
Unemployment vs
...
Expansionary fiscal policy
•
•
•
If the government increased spending (G), we would see an increase in
AD
...
As output increases, firms will hire more workers
...
Short run Phillips Curve
Therefore, we go from (A) unemployment (6%) and low inflation (2%), and
move to point (B) unemployment (3%) and higher inflation (5%)
...
Fiscal policy
reduces unemployment and causes higher economic growth, but leads to higher
inflation
...
Expansionary fiscal policy (higher G / lower tax) will lead to a bigger
budget deficit
...
If we reduce AD (e
...
higher interest rates), we
can get lower inflation, but we may cause unemployment
...
If AD increases at the same rate as AS, we can get economic growth
without inflation
...
Other potential policy conflicts
•
•
•
•
Higher economic growth may cause environmental problems – e
...
the
overuse of scarce limited resources acts as a constraint on future living
standards
...
Cutting down benefits may provide an incentive for the unemployed to
get a job, but it may cause increased inequality
...
Title: A* Economics Notes Theme 1 and 2
Description: A* Notes on As Economics for first year A-Level takers with detailed information and detailed diagrams.
Description: A* Notes on As Economics for first year A-Level takers with detailed information and detailed diagrams.