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MACRO ECONOMICS
•
Macroeconomic policy objectives - There are 4 common objectives held by governments:
o Full employment
o Low and stable inflation
o Stable economic growth
o Satisfactory balance of payments
-
Inflation rate: 1
...
1 %
Unemployment rate: 3
...
olds 11
...
5%)
GDP Q4 2017/YoY: 0
...
5]
Interest Rates: 0
...
(7
...
9 bn
...
5 m Q3 2018 3
...
5%
o Danger of Inflation as the economy overheats
o Strong and Rising levels of consumer spending
o Growth in employment, and labour may experience an increase in wages
o More demand for imported goods
o Increased demand for houses and house price inflation
o Increased company profits
•
Economic Recession
o Falling demand for UK goods
o Rising unemployment & Falling Living Standards
o Falling government tax receipts
o Increased government borrowing and debt
o Sharp fall in business confidence and Investment
o Falling prices (Deflation)
o Fall in demand for imports
o Lower interest rates form central banks
•
Inflation - rate of change of the price level
•
Employment - If you are employed, you have a job
•
The balance of payments - The balance of payments is a record of a country’s transactions
with the rest of the world over a year (Current account; Capital account; Financial account)
•
The circular flow model - how the entire economy functions in basic terms
•
The two key components:
o Households - owners of the factors of production
o Firms - producers within the economy
•
Injection (J): Spending that does not come from households
o Investment (I)
o Government expenditure (G)
o Exports (X)
•
Withdrawals (W): Income earned by households that is not spent on domestic final good
and services
o Savings (S)
o Taxes (T)
o Imports (M)
•
Aggregate demand (AD) - total demand for a country’s goods and services at a given price
level AD = C + I + G + (X – M)
•
Consumption (C)
C = domestic consumption (Cd) + import consumption (M) Spending by firms is NOT included
in consumption
•
Why is AD downward sloping:
o The wealth effect - The amount people’s wealth can buy will increase or vice
versa (falling real incomes)
o The interest rate effect - Interest rates will fall, causing increases in consumption
and investment
o
Net exports increase - The country’s goods / services become internationally
more competitive
•
We tend to look at what consumers can buy with their disposable income (Yd)
∆𝑪
•
Marginal propensity to consume 𝐌𝐏𝐂 = ∆𝒀
•
MPC + MPS = 1
•
Investment (gross) refers to spending by firms (or government) on all capital goods
•
The multiplier effect - increase in final income arising from any new injection of spending
...
•
Classical theory - There is a limit to how much firms can increase their supply since there
are capacity constraints
•
AS - Long run and Short run
•
SRAS - upward sloping since it is the sum of all supply curves within the economy
•
Long Run - the total quantity supplied at different price levels over a time period when the
prices of FoPs can change
•
Classical theory - There is a limit to how much firms can increase their supply since there
are capacity constraints
•
Classical economists dislike policies that shift only aggregate demand
Price
level
LRAS
•
Keynesian - Keynesian economists identify long periods where markets have been in
disequilibrium
•
Keynesian economists dislike supply side policies unless the economy is operating on the
vertical portion of LRAS
•
The LRAS curve is equivalent to the PPF
•
Actual growth - the rate of change of GDP
o It may be due to increases in aggregate demand or increased efficiency
o Corresponds to what is happening in the SR AD / AS curve
...
•
Economic growth - The % Change in an Economy’s Real GDP (Output/Income/Expenditure)
...
This will create short term growth (pushing the economy back to trend)
...
Hence an increase in AD will
move the economy closer to its PPF: This reduces the ‘negative’ output gap
•
Benefits of economic growth
o Economic growth increases national income
o This can reduce poverty
o It can enable more people to consume luxury goods
o It can increase expenditure on publicly provided goods / services e
...
education
and healthcare
o It can increase a country’s status and international power, leading to more
favourable outcomes in international negotiations
•
What are the causes of economic growth?
o Investment: Spending on capital goods, such as premises, machinery and equipment
...
o Changes in technology: Technological process means the quality of capital goods
improves and this capital can now produce more output than before
...
There
may be a natural increase in the working population (e
...
more school leavers), or
immigration may bring more workers
...
The more
educated, trained and skilled workers, the higher the output of the country is likely to
be
...
The discovery and exploitation of North Sea oil has increased UK’s
economic growth rate over the years
...
The effectiveness of government policies can have a
significant bearing on the economic growth rate
...
o Governments now also stress the importance of achieving steady and sustainable
economic growth
...
o Sustainable economic growth is growth that can continue over time and does not
endanger future generations’ ability to expand productive capacity
...
•
Advantages of economic growth
o Faster economic growth should lead to a rise in living standards (as measured by
real GDP per head) – Enables consumers to buy more goods and services
...
o Economic growth should reduce unemployment
...
o Economic growth has a positive impact on the government’s finances
...
Alternatively, the government can raise spending on education
and health and/or benefits for poor people, without having to raise taxes or cut
current consumption levels
...
o Higher demand and output encourage greater investment in new capital
machinery via the accelerator effect
...
o Firms benefit from higher sales revenue and increased profits
o Greater economic status and power e
...
trading platform
...
Higher prices may reduce the
UK’s international competitiveness, as UK exports suffer
...
g
...
Also,
coal, oil and gas will eventually run out
...
g
...
Such will harm social welfare and those adversely affected, may experience a decline
in living standards e
...
health
o Benefits of economic growth may not be evenly distributed
...
o Social effects: People may be forced out of towns, as they are being developed, during
periods of rapid growth
o Increased stress: May result in higher divorce rates
...
o Having more goods and services may not increase happiness – wants are unlimited
•
Conflict
o Economic Growth and Inflation
§
When the Economy grows, people will often find that there are more jobs
available
...
This is likely to increase spending in the Economy and cause
inflation
...
It is usual that our incomes grow, we increase
spending
...
This is known as the propensity
to import
...
o Lower indirect tax then this will lower the prices of the taxed goods and encourage
more demand
...
This will raise people's disposable income (their take-home pay) and
therefore encourage them to spend more
...
o Fiscal policy may have time lags
...
•
Monetary Policy – expansionary
o If the Bank of England decreases interest rates, it will tend to increase overall demand
in the economy
...
o Lower interest rates reduce the cost of mortgage interest repayments
...
o Lower interest rates reduce the incentive to save
...
•
Problems with Monetary policy
o Lower interest rates may not help boost spending, if banks are still reluctant to lend
o If it has been for many years, it may not work
•
Supply-Side Policies - policies that aim to increase the capacity of the economy to produce
...
o This will be true at most income levels
...
o If income tax on high levels of income is too high, people may choose not to work so
hard and take risks
...
•
Negative
o Generally take a long time to take effect (6-10 yrs)
o Costly
o Uncertainty if they will actually work (Welfare to work scheme)
•
Fiscal policy long run, capital
o Decrease the lower and basic rates of tax to open up the gap between earnings in and
out of work and ensure people have an incentive to work
o Decrease the level of personal allowances for the same reason
o Decrease the top rate of tax to encourage enterprise, risk-taking and the incentive to
work hard
•
Unemployed - people who are registered as able, available and willing to work at the going
wage rate but who cannot find work despite an active search for work
...
•
Labour Force Survey measures the unemployed who are without any kind of job including
part time work but will start work in the next two weeks
...
This is also known as Keynesian unemployment or demanddeficient unemployment
...
;
Negative Output Gap
•
Structural (supply side) - there is a long-term decline in demand in an industry leading to
fewer jobs as demand for labour falls away
...
This problem is due to occupational and geographical
immobility of labour
•
Frictional - is transitional unemployment due to people moving between jobs
...
g
...
)
•
Tax break - taxpayer who ends up paying less in taxes to the government
...
g
...
Prices are still rising but at a
slower rate
...
•
Demand Pull inflation
o Caused by excess aggregate demand
o Often linked to a money and credit boom
o Economy close to full capacity (inelastic AS)
o Positive output gap (AD > potential GDP)
•
Cost Push Inflation
o Rising wage costs in labour market
o Increasing raw material and component costs from domestic and overseas suppliers
o Rising import prices due to a falling exchange rate – this increases import costs
•
Inflation is always & everywhere a monetary phenomenon - Milton Friedman
•
Why is High Inflation an Economic Problem?
o Inequality: Inflation has a regressive effect on lower-income families in developed &
developing countries – most of their wealth is held in cash
o Falling real incomes – if wage rises lag behind price increases each year
o Negative real interest rates: If the interest on savings is lower than inflation
o Cost of borrowing: High inflation may also lead to higher interest rates for businesses
and consumers with debts (e
...
Rising mortgage rates)
o Risks of wage inflation: This leads to rising labour costs and lower profits
o Business competitiveness: A high relative rate of inflation can reduce competitiveness
which will lower demand for the country’s exports
o Business uncertainty: High and volatile inflation is not good for confidence partly
because businesses cannot be sure of what their costs and prices are likely to be
...
•
shop around for a cheaper alternative
•
This is the cost of changing price lists, which incurs a cost
...
Psychological & Political
•
People are uncertain what to spend their money on
...
•
This uncertainty and confusion can lead to lower rates of
economic growth over the long term
...
•
Inflation will typically make borrowers better off (real value of
debt will diminish) and lenders worse off
...
However, it does depend on the real rate of
interest
...
g
...
Unemployment and Growth
•
High inflationary growth is unsustainable and is usually followed
by a recession
...
•
Sustainable, low inflationary, economic growth is highly desirable,
to avoid unemployment
...
Cost of reducing inflation
o Higher interest rates to reduce spending and investment
...
•
The Exchange Rate - It is the price that one currency can be converted for another
...
•
Demand for currency
•
Supply of currency
•
Sale of UK exports create a demand for £ from
•
Purchase of US Imports create a supply of £ as
Americans
the British require $ to buy American goods
•
(X – Goods and Services)
•
(M – Goods and Services)
•
Inward investment in the UK create a demand
•
Outflow of investment creates excess supply of
for £ from Americans
•
Speculative Demand in favour of currency -
the £, as the British want $ to invest in America
•
creates a demand for £ from Americans
Speculation against ‘£’ creates a supply of
currency because the British want $ thinking it
will be worth more
...
o Economic Growth - rapid growth may lead to the ‘sucking in’ of imports by
domestic consumers
o Fiscal Policy - Countries with strong public sector finances tend to have a stronger
exchange rate ‘£’
...
Imports
Makes UK goods more expensive when
priced in a foreign currency
•
Demand for UK exports should rise
•
Demand for UK exports should fall
•
Imports become more expensive for UK
•
Imports become cheaper for UK
(M)
•
consumers – demand for imports
consumers – demand for imports
should fall
...
Increase costs of production for firms
•
Reduce costs of production for firms
who use imported goods in their
who use imported goods in their
production process – Cost Push
production process
Inflation
...
decrease in GDP (AD shift left)
...
Current Account - payments for purchase and sale of goods and services are recorded
+ Trade balance in services (=Trade balance in goods and services) + Net investment income
+ Transfers =
Current Account balance =
o Trade balance in goods: finished goods, raw materials, energy products, Capital
technology
o Trade balance in services: Nanking, insurance, consultancy, tourism, transport,
shipping, education, health research
o Net Money Transfer: oversea aid / debt relief
o Net investment Income from Overseas Assets: profits, interest and dividends
from investment in other countries
o
•
The Capital and Financial Accounts - flows of money associated with saving, investment,
speculation and currency stabilization are recorded
Financial Account:
o Direct investment
o Portfolio investment
o Financial derivatives (net)
o Other investment
o Reserve assets