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2020 Edition

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A-LEVEL ECONOMICS

REVISION FLASH CARDS
Edexcel A

MACRO

PAPER 2

THEME 2

THE UK ECONOMY PERFORMANCE AND POLICIES
GROWTH

MEASUREMENTS
OF GROWTH

• GDP *
• GDP per capita
• GNI = GDP + (net) money made on
overseas investments
• GNP = GDP + value generated by expats
abroad
• PPP = using exchange rate to compare
affordability of a ‘basket of goods’ across
nations
...
1 MEASURES OF ECONOMIC PERFORMANCE

GDP - BENEFITS & LIMITATIONS AS A MEASURE

BENEFITS

LIMITATIONS

• Internationally comparable measure
• Easy to calculate - therefore low (opportunity) cost for governments,
particularly those in developing nations that may not have a lot of cash
• Requires less data than some more complex measures (e
...
HDI), reducing the
chance of (data) inaccuracy
• Inaccuracy (difficult to collect & calculate in some countries)
• Inequalities – does not take into account or reflect levels of inequality
(income distribution) in the nation
• Quality of goods and services – does not reflect the quality of goods &
services
• Education and healthcare – GDP does not take into account quality of
education and healthcare, which are important factors in the development
of a nation
• Happiness - some argue that happiness is more important to development:
‐ UN - 6 happiness factors: income, life expectancy, social support
(having someone to depend on), corruption, generosity, freedom to
make choices)
‐ UK - national wellbeing report → 4 factors of development: life
satisfaction, anxiety, happiness, worthwhileness
‐ Easterlin paradox - limit to how much money (income) can make you
happy
...
1 MEASURES OF ECONOMIC PERFORMANCE

INFLATION (1)

MEASUREMENT

→ Calculated through surveys
→ Treat one year as base year with a base figure (starting point) of 100
• CPI → Living Costs & Food Survey
• RPI → Retail Price Index (price of goods)

DEMAND-PULL

CAUSES OF
INFLATION

COST-PUSH

MONEY

• When demand is greater than supply

• When increasing costs of production or
supply issues (e
...
in oil industry) push prices
up
• When the Bank of England prints too much
money or banks provide too much credit to
consumers and businesses

THEME 2
...
P
...
W

CONSUMERS

PRODUCERS

GOVERNMENT

WORKERS

COSTS
• Living standards worsen due to
reduction in purchasing power
• Increases inequality
• Well-being: psychological impact of
inflation
• Loss of consumer confidence
• Savings are less valuable

BENEFITS
• Debt - the cost of paying off debt
becomes cheaper

• Spending/Investment
• Cheaper to pay staff as cost (real
• Reduction in competitiveness of
cost) wages falls
exports - exports become more
• Real value of debt falls - cheaper to
expensive, leading to less demand
repay
• Menu Costs/Shoe-Leather Costs costs involved in printing new menus
& counteracting effects of inflation
• Loss of business confidence
• Value (real value) of tax revenues fall
• Worsens the current account of the
Balance of Payments
• Wages (real value) fall
• Job losses - if deflation as wages
become expensive

• Cheaper to borrow new money and
finance current borrowing
• Value (real value) of national debt
smaller
• Makes it easier for companies to
increase wages (though they may
not increase by as much as inflation)

THEME 2
...


THEME 2
...
g
...
g
...
Caused by the boom
& bust cycle
STRUCTURAL
Long term unemployment where jobs become
obsolete e
...
an economy changing from
manufacturing to service-based, such as the
U
...

• 3 types:
‐ Regional
‐ Sectoral
‐ Technological

SKILLS
• Not having the right skills, so they’re not
transferable e
...
difficult to move from
manufacturing to technology

THEME 2
...
P
...
W
...
1 MEASURES OF ECONOMIC PERFORMANCE

BALANCE OF PAYMENTS
CURRENT ACCOUNT

Capital Account and financial accounts (see theme 4)

THEME 2
...
You will save even more
and spend less
...
2 AGGREGATE DEMAND

AGGREGATE DEMAND (2)
A closer look at the individual components of the equation:

1
...
INVESTMENT (I)
FACTORS AFFECTING INVESTMENT
• Interest rates - reflects how expensive it is to
borrow money to fund investment
• Confidence/ expectations of the future
• Demand for exports - if "business is boomin'",
you will invest more
• Regulation
• Technology
• Access to credit - in recessions, it becomes
more difficult to borrow; in economic
expansions, credit is more readily available

THEME 2
...
GOVERNMENT SPENDING (G)
FACTORS AFFECTING GOVERNMENT SPENDING
• Fiscal policy - budget decisions
• Age demographics
‐ if ageing population → increased
spending on pensions, social care
‐ if young population → increased
spending on education
• Economic cycle - boom and bust
‐ Boom → less spending to manage
inflation
‐ Bust → more spending on welfare and
benefits

4
...
3 AGGREGATE SUPPLY

AGGREGATE SUPPLY: SHORT RUN VERSUS LONG RUN (1)
Definition: volume of goods/services produced at a given price (level) in a country

SRAS

LRAS

Factors of production are they fixed or variable?

Fixed

Variable

Shape of the AS curve

Upward sloping (like
riding up a hill)

• Classical - Vertical line
• Keynesian - Goes from horizontal to vertical

Influencing Factors
(that cause AS to shift)

Change to cost of
Production:
• Costs of raw materials
• Changes in exchange
rates
• Tax rates

Changes to the quantity or quality of factors of
production - this is equivalent to shifting the production
...

There are 2 categories:
(1) INTERVENTIONIST: Interventionist policies aim to
address market failure, such as the underprovision of
public goods
...
It involves:
• Investment in:
‐ Technology
‐ Infrastructure
‐ Productivity
* Labour (skillset)
* Efficiency
‐ Education & skills

THEME 2
...

It is preferred by economists who believe in free
markets and want the government to have as small a
role as possible
...
g
...
3 AGGREGATE SUPPLY

AGGREGATE SUPPLY: SHORT RUN VERSUS LONG RUN (3)
SRAS
Can exceed max
potential?

Yes - since people
can work overtime to
produce more

LRAS
No - since all resources are fully utilised
NB
...
It takes 20-30years
...

For this to happen, it means that at various points in time, there are unused factors of production
...
There’s a process the economy goes
through for the curve to become vertical
...


continued overleaf

THEME 2
...

Keynes uses labour, the 2nd of the 4 factors, to further demonstrate this point
...
And if they’re unemployed, that
means they aren’t earning a wage (salary)
...
This is why the Keynesian LRAS curve starts off horizontal, because a firm can boost output (production)
without increasing their costs (the price level)
...

As firms continue to do this (hire more workers), fewer become available
...
Eventually no more workers are
available, and firms can no longer increase production (output) since all factors of production have become
exhausted
...


THEME 2
...

• It looks at the interactions between firms and households
‐ Firms provide goods and services for households in return for payment;
‐ Households provide labour, land, capital (i
...
the factors of production)
in return for a wage or salary, rent and profit
...
There’s far more going on
and other people involved e
...
government and the financial sector

• Money enters and leaves the economy that isn’t considered by the model
...
4 NATIONAL INCOME

MULTIPLIER
• Multiplier refers to the idea that if we inject or put money into the economy, we can get the
economy to grow by an even bigger amount than the money we put in
...

‐ If we (government, financial sector) put money into the economic system, that money becomes
income for people
...

‐ And since we know spending is represented by consumption ‘C’ in the AD equation, then aggregate
demand should grow, meaning the economy has grown
...
We measure this by MPC, the marginal propensity to consume
‐ The more of it people spend, the less of it has ‘leaked’ out (through savings, tax, imports), and
therefore the bigger the multiplier
...


THEME 2
...
Economic growth - occurs when there’s an increase in either the quality or
quantity of the 4 factors of production
...
An increase in these factors means that a country now has the potential to
produce more
...
e
...

3
...

• Economists prefer to use real GDP instead of nominal GDP because
nominal GDP has a flaw in that its value can increase due to the prices
of goods and services (inflation) rising, without more goods actually
being produced
...

• This increases AD
• As export demand rises, firms will invest and increase demand for
labour, shifting LRAS and leading to economic growth
• Successful examples of this are Germany and Japan
...


EFFECTS OF ECONOMIC GROWTH
Use acronym: C
...
G
...
g
...
g
...
5 ECONOMIC GROWTH

OUTPUT GAPS
Output gap is the difference between the actual growth in GDP and the estimated level of GDP, known as
trend
...

• If the equilibrium lies to the left of the LRAS → negative output gap
• If the equilibrium lies to the right of the LRAS → positive output gap
MEASUREMENT
Difficult to measure output gap for the same reason as potential growth - no one knows the position of the
LRAS or PPF
...
How do you assign a value to the different factors?
‐ Take labour for example, what value do you assign to the different types of labour? Is a waiter more
valuable than someone stacking shelves in the supermarket? Is a factory machine that produces car
parts more valuable than the one producing screws?
‐ It’s impossible to assign a value to all the different variables, and that’s why we don’t really know at
what point on the LRAS the economy is at
...
5 ECONOMIC GROWTH

TRADE (BUSINESS) CYCLES
The economy regularly moves up and down in terms of GDP growth
...
This is
known as a boom or expansion
...
This is known as
a recession or contraction
...
6 MACROECONOMIC OBJECTIVES AND POLICIES

MACROECONOMIC OBJECTIVES

These are the broad goals (the ‘big picture’ goals) that the government wants to achieve
...
K
...
5%
...
And for good reason: the
government wants as many people employed as possible as it creates a healthy economy
...


Balance of
payments
Balanced
government
budget
Environmental
Protection

Trade-offs

Income
equality

• The government wants the ‘current account’ element of BoP in equilibrium as it means
they’re more likely to have healthy finances
...
And this leads to debt, which can spiral out of control
...

• Reducing the gap between rich and poor by making sure wealth is more fairly
distributed and taxes do not disproportionately affect the poorer segment of society
...
For example, unemployment and inflation:
• You can decrease unemployment but it will lead to higher prices (inflation) as wages tend to rise
when unemployment falls
...


THEME 2
...
e
...
In both cases, they create
problems, whether that is unemployment or
inflation, for example
...
As the name suggests, one attempts
to address (aggregate) demand and the other
(aggregate) supply issues
...
Demand policies
Designed to increase consumer demand (C) in
order to increase aggregate demand (AD)
...

Expansionary increases AD and employment, and
is useful in recessions; contractionary decreases
AD in order to control inflation, and so is useful
when the economy is growing too quickly (boom)
...
6 MACROECONOMIC OBJECTIVES AND POLICIES

MACROECONOMIC POLICIES: DEMAND-SIDE POLICIES (2)
When asked about demand-side policies, answer the question by considering the following points:
Does AD increase/decrease through a change consumption, investment, government spending or net trade?
(N
...
AD = C + I + G + X-M)
1
...
Output - does it increase or decrease?
3
...
Inflation - does it go up or fall?
5
...
6 MACROECONOMIC OBJECTIVES AND POLICIES

MACROECONOMIC POLICIES: SUPPLY-SIDE POLICIES (1)
MARKET-BASED
2
...
These
policies can be used to target the whole economy,
or just parts of it
...


Designed to remove barriers to the free market

Promoting Competition
Makes firms more competitive
...
Policy
choices include:
• deregulation
• privatisation (e
...
of rail network, power network etc)
• trade liberalisation - encouraging cross-border trade
Labour market reform
• union reform (reducing their power)
• minimum wage reform
• working age reform
• unemployment benefit reform
All these are designed to reduce unemployment, and in
turn boost production, increasing aggregate supply
...
g
...
6 MACROECONOMIC OBJECTIVES AND POLICIES

MACROECONOMIC POLICIES: SUPPLY-SIDE POLICIES (2)
When asked about supply-side policies in the exam, answer it by addressing the following points:
1
...

3
...

5
...


Productivity - does it increase or decrease?
Efficiency - does it improve or worsen?
AS curve - does it shift left or right?
Output & economic growth - does it increase or decrease?
Inflation - does it go up or fall?
Unemployment - does it fall or get worse?

THEME 2
...


INTEREST RATES
Bank of England can lower or raise interest rates to increase or decrease AD respectively
AFFECTS:
• Cost of borrowing - e
...
higher interest rates
makes it more expensive to borrow money for
Consumption (C) and Investment (I), reducing AD
• Marginal propensity to consume (MPC)
- higher interest rate makes saving more
attractive, which means less spending
(consumption)
...

• Business and consumer confidence - a change
in interest rates can affect confidence and lead
to a fall in consumption and investment, and
consequently a fall in AD
...
Higher interest rates make it
more expensive to pay off a mortgage; people
use more of their salary to pay off your
mortgage each month
...


AFFECTS:
Bonus marks:
‐ Wealth effect
...
This will lead to less
spending on (financial) assets like shares and
bonds, leading to a fall in the price and value
of these assets
...

‐ Higher interest rates mean foreigners want
to hold their money in British banks
...
But a higher pound value
makes our exports more expensive and imports
cheaper, affecting net trade (X-M) and therefore
AD
...
6 MACROECONOMIC OBJECTIVES AND POLICIES

DEMAND-SIDE POLICIES (DETAILED): MONETARY POLICY (2)

INTEREST RATES
Bank of England can lower or raise interest rates to increase or decrease AD respectively
CONS:
• Value of currency
...

• Time lags
...

• Minimal impact
...

• Trade-off in objectives
...


• Trade-off in objectives:
‐ Contractionary monetary policy - when
interest rates are increased - can
lead to lower inflation but higher
unemployment
...


THEME 2
...

• The hope is that the companies that receive this
money should then spend it on goods, services,
and other financial assets, increasing their
price and leading to more Consumption (C) and
Investment (I) due to this positive wealth effect
...
Can cause very high inflation
(hyperinflation)
...
g
...

This has the effect of increasing prices without
increasing AD
...
It raises the value of the
stock market, and it’s mainly rich people that
invest in the stock market
...

‐ Expansionary monetary policy - that is, when
there’s more quantitative easing - can lead to
lower unemployment but higher inflation
...

‐ So there’s a tradeoff between the
government’s objectives of having both low
stable inflation and low unemployment
...
6 MACROECONOMIC OBJECTIVES AND POLICIES

DEMAND-SIDE POLICIES (DETAILED): FISCAL POLICY DEMANDChanging taxes or government spending to change aggregate demand (AD)

TAXES
AFFECTS:
• Changing taxes can give people more disposable
income, increasing consumption and leading to
an increase in AD
...


CONS:
• Cutting taxes/increasing spending can worsen
government budget -- lead to a budget deficit
...

• Can affect LRAS e
...
if government cuts
spending, it can affect education and
development of new technologies, both
important for LRAS
...

• Time lags
...


CONS:
• Trade-offs in objectives
...

‐ Contractionary fiscal policy - when there’s
decreased government spending - can
lead to higher unemployment but lower
inflation
...
The
government can not achieve its objectives of
both low unemployment and low inflation at
the same time
...
If the multiplier is high, then fiscal
policy has a higher impact on AD
...
6 MACROECONOMIC OBJECTIVES AND POLICIES

POLICIES: MONETARY VERSUS FISCAL POLICY
• Monetary policy can increase AD without increasing fiscal deficit of the government, an important
objective for governments (especially Conservative ones)
...

• Fiscal policy also has the added benefit that you can target spending at specific groups of people in
society to reduce poverty/inequality
...
6 MACROECONOMIC OBJECTIVES AND POLICIES

POLICIES: EVALUATION
When evaluating macroeconomic policies, include the following points:

FISCAL

MONETARY

DEMANDSIDE

SUPPLYSIDE

• Time lags
• Government can increase AD
without increasing spending and
worsening their deficit
• Limited effectiveness in increasing
AD when country already in
recession
• Tradeoffs between objectives e
...

tradeoff between unemployment
and inflation (Phillips Curve)

•
•
•
•
•
•
•
•

•
•
•
•

Time lags
Effectiveness during recessions
Impact on government fiscal potential
Opportunity costs i
...
choosing
one policy action over another e
...

investment in NHS versus housing
• Impact on the poor and inequality
• Does not address supply-side issues
• Tradeoffs between objectives e
...

trade off between unemployment and
inflation (Phillips Curve)

Time lags
Ability to reduce inflation and unemployment at the same time
Ability to increase output and decrease prices
Impact on economic growth
Impact on government budget
Impact on environment
Impact on poor and equality
Tradeoff between:
‐ economic growth and environment (China)
‐ economic growth and balance of payments (India)
one objective tends to improve at the expense of another

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