Chains of analysis economics macro

Consumption

1. (due reason for rise in consumption)e.g fall in taxation

2. increase in consumer spending

3. increase in demand for goods and services throughout the economy

4. increase in aggregate demand (AD to AD1)

5. increase in national income (real GDP) short-run economic growth.

Consumption - Possible triggers for a rise in consumption list - (8)

1. Increase in disposable income

2. Fall in taxation / increase in Personal Allowance

3. Positive wealth effect

4. Consumer confidence

5. Reduction in interest rates

6. Increase in availability of credit

7. Inflation expectations

8. Fall in savings ratio

Government spending

1. increase in GS becomes peoples incomes

2. increase in demand for goods and services throughout the economy

3. injection into the circular flow of income

4. increase in aggregate demand (AD to AD1)

5. derived-demand for labour = fall in unemployment.

Investment - Possible triggers for a rise in investment: (4)

Fall in interest rates

Fall in cost of capital

Increase in technological progress

Increase in business expectations

Investment

1. Fall in interest rates

2. lowers cost of borrowing for firms

3. increase in Marginal Efficiency of Capital

4. increase in investment (demand for capital goods)

5. increase in productive capacity of economy (long-run economic growth).

Net Exports (X-M) - Possible triggers for a rise in export revenue (3) list

1. Fall in exchange rates

2. Improved economic performance of trading partners

3. Relatively lower inflation rate

Possible triggers for a fall in export revenue: (3) list

1. Rise in exchange rates

2. Worsening economic performance of trading partners

3. Relatively higher inflation rate

Decrease IR = increase exports

1. A reduction in the Rate of interest

2. reduction in reward for international saving and outflow of hot money

3. increase in supply of sterling

4. fall in Sterling exchange rate

5. lower external price of UK exports = increase in demand for X

inflation correction by falling C/A (7)

1. A relatively high inflation rate in UK

2. increase in external price of UK exports

3. reduction in international price competitiveness

4. fall in demand for UK exports

5. smaller injection than planned into circular flow of income

6. fall in aggregate demand

7. fall in demand-pull inflationary pressure.

triggers for a rise in import expenditure (3)

1. Fall in interest rates

2. Rise in national income

3. Relatively higher inflation rate

Possible triggers for a fall in import expenditure: list 3

Rise in interest rates

Fall in real output

Relatively lower inflation rate

Fall in bank rate triggers for a rise in import expenditure (10)

1. A fall in Bank Rate

2. lower cost of borrowing for commercial banks

3. lend more so reduction in interest rates for borrowers

4. lower cost of borrowing for consumers

5. increased spending on goods and services

6. UK has a particularly high MPM (35%)

7. increase in demand for imports

Multipliers - Withdrawals from circular flow

Saving (Savings Ratio - SR)

Import expenditure (Marginal Propensity to Import)

Taxation (Marginal Rate of Tax - MRT)

Multipliers - Positive multiplier effect

1. E.g. Increase in investment

2. increase in demand for capital goods

3. injection into the circular flow of income

4. increase in AD/RNO increase in derived-demand for labour

5. increase in disposable income

6. increase in demand in a different market e.g. for consumer goods

7. subsequent secondary spending rounds

(AD1 to AD3)

8. additional increases in real output (Y1 to Y3)

Multipliers - Negative multiplier effect

1. E.g. Rise in exchange rate

2. lower cost of imported goods

3. increase in demand for imports relative to domestic goods

4. reduced demand for UK goods

5. fall in derived-demand for labour

rise in unemployment

6. fall in household disposable income

7. fall in consumption and fall in aggregate demand (AD to AD1)

8. decrease in demand in other markets

9. subsequent secondary spending rounds

(AD1 to AD3)

10. additional decreases in real output (Y1 to Y3)

Accelerator - Expansionary demand-side policy 6

1. Expansionary demand-side policy

2. rise in rate of economic growth

3. firms close to full capacity increase capital expenditure in anticipation of future increases in demand for goods

4. higher proportional increase in rate of investment

5. injection into the circular flow of income

6. increase in aggregate demand (AD to AD1)

Productivity Gap - Possible causes of productivity gap with G7 4

1. Low levels of investment

2. Lower R&D

3. Worse education/skills of labour force

4. Over-regulation

low levels of investment then low int comp (why supply side policies) (7)

1. Relatively low levels of investment

2. less up to date capital machinery / technology

3. less innovation

4. reduced output per input

5. reduced labour productivity

6. higher per unit cost

7. less international competitiveness.

Supply-Side Policies examples

1. Labour market: education and training to improve occupational mobility

2. Labour market: infrastructure and transport networks to improve geographical mobility

3. Labour market: lower taxation to improve incentives to work

4. Labour market: lower benefits to improve incentives to work

Labour market: trade union reform to improve flexibility

5. Product market: privatisation

6.Product market: deregulation

7.Product market: outsourcing/contracting out

8. Production market: competition policy

9. Capital market: lower taxation to encourage investment in R&D

10. Capital market: regulation and deregulation of financial markets

Supply-Side Policies coa

1. e.g Government reforms of education

2. increase in human capital (stock of skills and knowledge)

3. increase in labour's productive potential

4. increase in potential output in economy

5. long run economic growth

expansionary fiscal A reduction in direct taxation (6)

1. A reduction in direct taxation (e.g. increase in 40% income tax band from £46,350 to £50,000 in 2019)

2. increase in household disposable income

3. increase in consumer spending

4. increase in demand for goods and services throughout the economy

5. increase in aggregate demand (AD to AD1)

6. increase in national income (real GDP) = short-run economic growth.

Financial Crowding Out chain

1. Government incurs a budget deficit

2. issues more bonds in Primary Capital Market

3. increases demand for loanable funds

4. government must increase coupon rate on bonds to attract investors/savers seeking a balanced portfolio

5. commercial banks must raise their interest rates in response to attract savers

6. higher cost of borrowing throughout the economy

7. lowers borrowing and spending by consumers and firms

8. financially crowds out private sector decreasing AD

Monetary Policies decrease Bank rate

1. A fall in Bank Rate

2. lowers cost of borrowing for commercial banks

3. lowers mortgage interest rates whilst maintaining spread

4. increases demand for mortgage credit

5. increases demand for houses increase in house prices

6. increase in positive wealth effect

7. increase in consumer spending

8. increase in aggregate demand

monetary policy increase Bank rate (2)

1. A rise in Bank Rate

2. increases reward for saving

3. decreases borrowing

4. decrease consumer spending

5. decrease AD

ALSO:

1. attracts international hot money flows

2. increase in demand for Sterling (D to D1)

3. increase Sterling exchange rate

4. lowers cost of imported raw materials (COP)

5. increases domestic supply

Monetary Policies Unconventional - Includes (3)

Quantitative Easing (QE)

Funding for Lending

Forward Guidance

Monetary Policies QE

1. Bank of England creates digital money

purchases back previously issued gilts and targeted private sector bonds from large banks

2. increases liquidity (broad money) and lowers yield in Secondary Capital Markets

3. banks spend this on investment or loan to customers for investment/consuption

4. banks spend this on buying shares/bonds which boosts prices and coupon which decreases yield so long term interest rates fall,

lower cost of borrowing for firms

5. increases private sector investment and consumer consumption

6. increases aggregate demand (AD to AD1), short run economic growth.

low to high Unemployment - explains Phillips Curve (Short Run)

1. Expansionary demand-side policy

2. increases demand for goods and services throughout the economy

3. increases aggregate demand (AD to AD1)

4. increases derived-demand for labour

5. lowers unemployment

6. when economy is close to full employment workers and trade unions exploit labour shortage and increase wage rates

7. higher cost of production

8. firms supply less for any given price level (AS to AS1)

cost-push inflation (movement up and to the left along SRPC1).

Unemployment - Phillips Curve (Long Run)

1. Higher inflation in the economy

2. money illusion wears off

3. workers and firms realise that their real incomes have not increased

4. lowers demand for labour and lowers supply of labour at prevailing wage rate

6. unemployment returns to natural rate (or NAIRU)

7. economic agents have now adjusted their expectations of inflation

8. economy rests at higher inflation rate (jumped up and to the right on SRPC2).

Price instability

1. Price instability

2. uncertainty about costs, prices and revenue

3. caution/inaction

4. reduced consumer spending (to increase consumer surplus) and reduced investment (to protect profits)

5. reduced aggregate demand in the economy

6. lower derived-demand for labour

7. falling national income and reduced economic growth.

Inflation - Cost-push causes include: 4

1. Fall in exchange rate / imported inflation (cost of imported raw materials and part-finished goods)

2. Rise in raw material costs

3. Tight labour market

4. Rise in indirect taxation

Deflation - Fall in cost of capital chain (6)

Fall in AD: malevolent deflation

Increase in AS: benign deflation

1. Fall in cost of capital

2. increases investment rate of return

3. increases investment within the economy

4. increases productive potential (LRAS to LRAS1)

5. fall in price level (P to P1)

6. benign deflation.

Trade - Comparative Advantage

1. each country specialises in the production of goods and services in which they have the lower opportunity cost

2. agree terms of trade that lie between the internal trade off ratio

3. higher total consumption of goods and services

4. increased social welfare.

Trade - Trade deficits - negative net imports (8 chains)

1. Trade deficit (import expenditure greater than export revenue)

2. withdrawal from circular flow of income

3. lower aggregate demand (AD to AD1)

4. fall in real output

5. lower derived-demand for labour

6. negative multiplier effect via reduced secondary spending rounds

7. additional rise in domestic unemployment.

Trade - Trade deficits - Overcome by - Central Bank

sells Sterling on FOREX

Overcome by

Expenditure reduction policies (contractionary fiscal policy)

Expenditure switching policies

E.g.

1.Central Bank sells Sterling/buys foreign currency

2. increases supply of Sterling (S to S1)

3. lowers exchange rate

4. decreases external price of UK exports

5. improves international price competitiveness

more exports sold

5. higher export revenue

6. reduction of trade deficit.

Protectionism - Forms include:

1. Tariffs

2.Quotas

3. Embargoes

4. Domestic subsidies

5. Product standards

6. Bureaucracy

Protectionism - eg Government introduces a tariff

1. Government introduces a tariff (e.g. on steel imports)

2. increases world supply price of steel imports

3. contraction of domestic demand and increase in domestic supply

4. reduction of imports (Q1Q2 to Q3Q4)

5. improvement in trade balance/increase in derived-demand for labour/increase in domestic output.

Globalisation Increase in international trade

1. Increase in international trade

2. increase competition between suppliers

3. greater choice of a variety of goods and

4. services at lower prices for consumers

5. increased social welfare.

Globalisation - Increase in labour supply

1. Increase in labour supply

2. increase in productive capacity of nations (LRAS to LRAS1)

3. lower wage costs

4. benign deflation.

Globalisation -

Increase in potential markets

1. Increase in potential markets

2. increase in output

3. economies of scale

4. lower LRATCs

5. higher profits ceteris paribus

6. increased investment in R&D

7. increase in aggregate demand (AD to AD1)

8.short run economic growth.

Aid - Government lends money to foreign nations

1. Government lends money to foreign nations

2. increase in infrastructure and education spending

3. increase in productive potential (LRAS to LRAS1)

4. increase in human capital

5. attracts FDI

6. increases aggregate demand (AD to AD1)

7. increases derived-demand for labour

8. increase in household disposable income

9. increase in both economic growth and economic development

Development Barriers - Race to the bottom / tax evasion

1. Race to the bottom / tax evasion

2. deprives government of tax revenues

3. reduced spending on state-run medical services

4. reduced life expectancy

5. since part of HDI slower development.

Development Barriers - Lack of private property rights

1. Lack of private property rights

2. dissuades entrepreneurial spirit since capital and profits can be captured by government

3. reduced investment

4. reduced pace of productive capacity growth

slower rising national incomes

5. since GNI is US$ PPP per capita is part of HDI

slower development.

Development Barriers - War and internal conflict

1. War and internal conflict

2. destroys physical capital (e.g. tarmac roads and rail lines) and human capital

3. higher costs of production

4. less supplied for any given price level

5. cost-push inflation

6. reduced international price competitiveness

7. fewer export sales

8. slower rising national incomes

9. since GNI is US$ PPP per capita is part of HDI

slower development.

Development Barriers - Lack of savings

1. Lack of savings

2. fewer loanable funds held in commercial banks

3. reduced credit available to firms

4. higher interest rates

5. reduced borrowing

6. reduced investment

7. reduced pace of productive capacity growth

8. slower rising national incomes

9. since GNI is US$ PPP per capita is part of HDI

slower development.

EU -list Benefits of Single Market and Customs Union include:

Benefits of Single Market and Customs Union include:

Four freedoms (free trade in goods, free trade in services, free movement of labour, free movement of capital)

Economies of scale / increased efficiency / lower production costs o Increased trade / economic growth / lower unemployment

Tradecreation/higherconsumerwelfare

Increased competition / lower inflation

Specialisation / improved trade balance

No trade deflection

EU -Benefits of Single Market and Customs Union include --> As a member of the EU then UK firms have tariff-free

As a member of the EU then UK firms have tariff-free access to 500m consumersprovides scope to exploit comparative advantage and specialise (e.g. in financial services)enjoy economies of scale (e.g. marketing) lowers average fixed cost of productionincreases profitsincreased investment in R&Dincrease in derived- demand for labourraises household disposable incomesaccording to Keynesian Consumption Function increase in consumer spendingincrease in aggregate demand (AD to AD1)economic growth.

EU - Costs of Single Market and Customs Union include list

Structural unemployment

Fragmentation

Race to the bottom

Trade diversion

EU - Costs of Single Market and Customs Union include --> UK must now set common tariff to non-EU member countries

UK must now set common tariff to non-EU member countries

loses non-member tariff-free (or low tariff) trade partners (e.g. New Zealand)

UK consumers now switch to EU suppliers at a higher than previous, but lower than tariff-imposed, price

reduced consumer welfare.

Money - Functions of money - A store of value and wealth

1. A store of value and wealth

2. enables savings

3. increases quantity of loanable funds

4. enables commercial banks to lend to firms

5. increases investment

6. increases demand for capital goods

7. increases aggregate demand (AD to AD1)

8. increase in real output

9. short run economic growth.

Money - Functions of money - A measure of value

1. A measure of value

2. enables price comparisons between differing goods and services

3. increases competition

4. encourages innovation and invention

5. increases choice and lowers price for consumers

6. increases social welfare

Money - Functions of money - A standard of deferred payment

1. A standard of deferred payment

2. facilities trade credit

3. enables firms borrowing

4. increases production

5. increases real output

6. increases derived-demand for labour

7. lowers unemployment.

Financial Markets - The money market - Supplying short-term funds adequately and quickly

The market for short-dated financial assets e.g. commercial bills or T-bills.

Supplying short-term funds adequately and quickly

an integral part of a developed economy and is indispensable for the rapid development of economies.

Financial Markets - The money market - Its smooth running list

Development of trade and industry

Non-inflationary source of finance to government.

Smooth functioning of commercial banks

Effective Central Bank control

Influences capital market

Financial Markets - The money market - Provides short-term credit facilities

Provides short-term credit facilities

enables firms to raise short-term funds via commercial bills

improves firms' liquidity

finances working capital requirements and operational expenses of trade and industry

e.g. paying bills, wages and raw materials

facilitates smooth functioning of businesses

maintains employment and real incomes.

Financial Markets - The money market - Enables governments to raise short-term funds

Enables governments to raise short-term funds via Treasury bills

reduces need to print/mint new money for expenditure

reduces excessive growth of money supply

via MV=PQ

limits inflationary pressure whilst facilitating fiscal and supply-side fiscal policies

macro objectives.

Financial Markets - The money market - Enables commercial banks to temporarily employ surplus funds profitably

Enables commercial banks to temporarily employ surplus funds profitably and in easily realisable assets

economising their cash balances at hand

enables them to meet their statutory requirements of cash reserve ratio (CRR) and liquidity ratio (LR)

without resorting to Central Bank funds

reduces systemic risk

stable economic growth

Financial Markets - The money market - Conditions prevailing in money market

Conditions prevailing in money market

clear signal to Central Banks of future inflationary pressure

provides information to implement suitable monetary policy

the sensitive and integrated money market

quick and widespread influence on submarkets

successful management of money supply

influences aggregate demand macroeconomic objectives.

Financial Markets - The money market - Interest rates prevailing in money market

Interest rates prevailing in money market

influence long-term interest rerates in capital market

cost of major borrowing for firms

investment

demand for capital goods

productivity capacity

long run economic growth.

The Capital Market - info

The market for medium and long-term borrowing.

Primary Capital Market e.g. new share issues, bonds and gilts and Secondary Capital Market e.g. trade of existing securities e.g. second hand issues, bonds and gilts.

Successful primary capital markets

mobilise resources

provides effective and efficient means of transfer

diverts them into productive channels

facilitates and promotes the process of economic growth and development.

The Capital Market - Their smooth running

Link between savers and investors

Encouragement to saving / opportunity for public to invest / attracts foreign funds

Encouragement to investment

Stability in security prices

Barometer of the economy

The Capital Market - Provides link between savers and investors

Provides link between savers and investors

brings together international buyers and sellers of securities

channels funds profitably from surplus to deficit economic agents (perhaps from different countries)

productive investment (including FDI)

increased productivity

increased aggregate demand and productivity capacity

short and long run economic growth (and development).

The Capital Market - Provides higher reward for long-term household saving

Provides higher reward for long-term household savings

increases saving within developing economies

reduces unproductive and wasteful spending on real estate and conspicuous consumption

increased productive investment

positive multiplier effects on macroeconomy.

The Capital Market - Increases mobility of capital

Increases mobility of capital

increases supply of capital

lowers interest rates

facilitates long-term borrowing

e.g. by firms via shares, bonds and debentures and by government via gilts

allocates funds towards productive investment spending by firms and government

encourages entrepreneurship

aggregate demand and supply

balanced and appropriate economic growth and development.

The Capital Market - Stabilises values of stocks and securities with similar risk

Stabilises values of stocks and securities with similar risk

reduces fluctuations in financial asset prices

lowers speculation and unproductive activities

lowers systemic risk

increases pace of stable economic growth and

development.

The Capital Market - Conditions and functioning provides barometer of economy

Conditions and functioning provides barometer of economy

information spread by media

informs public, firms and foreigners

re-allocates scarce resources to best uses

enables balanced portfolio decisions for long term investment

balanced and appropriate economic growth and development.

The Foreign Exchange Market (FOREX) - list Key functions

Unites the global financial centres of the world through 'exchange banks' (investment banks) which interact in the market in which foreign currencies are traded (e.g. $5 trillion worth of FOREX traded each day).

Key functions:

Transfer and credit functions

Hedging function

FOREX - Spot market facilities instant conversion of one currency into another

Spot market facilities instant conversion of one currency into another

transfers purchasing power between countries

enables international payments and debt clearance between nations

facilities FDI, trade and exploitation of comparative advantage

trade creation and its benefits

international (cross-border) investment

macroeconomic objectives.

FOREX - Forward market facilities

Forward market facilities

three month contracts to buy or sell FOREX at a fixed date in the future at a fixed rate

hedging against unanticipated or unfavourable movements

increased certainty and security

increased foreign credit (for short-term trade) and increased foreign capital transfer (long term investment)

increased globalisation, trade and development.

Commercial and Investment Banks - Role of Commercial Banks - Three key roles:

Accepting deposits

Credit creation and lending to economic agents

Efficient and secure means for payment

Role of Commercial Banks - Commercial banks accept/provide demand deposits

Commercial banks accept/provide demand deposits

whilst no interest is paid households' money is safe yet access is immediate and easy

provides means of carrying purchasing power into the future for households

facilitates larger purchases of consumer durables

enables both day-to-day and more sizeable transactions

stable aggregate demand

economic growth/low unemployment/price stability.

Role of Commercial Banks - commercial banks accept/provide time deposits

Commercial banks accept/provide time deposits

interest is paid as a reward for saving and notice must be given to withdraw

provides reserves that can be channelled into productive purchases

provides base for money creation

commercial banks make a spread on the higher interest rate charged on loans to borrowers

facilitates lending channel to economic agents

e.g. mortgages for households and loans for firms

investment and smooth functioning of housing market.

Commercial and Investment Banks - Bank Runs

Uncertainty surrounding commercial banks' ability to repay deposits

increased demand for depositors for their cash

insufficient liquidity (cash shortage) for commercial banks

banks must borrow from other banks (LIBOR) or seek emergency funds from Central Bank

if unsuccessful the bank becomes illiquid and fails (shuts down) leaving some clients without their deposits

increased uncertainty and reduced spending power

lower aggregate demand

recession (if bank failure significant).

Commercial and Investment Banks - Borrowing short, lending long

Banks become committed to paying other banks with money borrowed from the money market

during a credit crunch this is not possible since banks refuse to lend other than at punitive interest rates

negative spread between short-term borrowing and long-term (mortgage) lending

liabilities exceed asset base

eventual insolvency and bank failure.

Commercial and Investment Banks - Role of Investment Banks - Key roles include:

A bridge between investors and large enterprises (firms) and governments via share and debt issuances

Operates Money, Capital and FOREX Markets (see previous)

Provision of advice on mergers and acquisitions

Provision of research

Trading and sales

Asset management

Wealth management

Commercial and Investment Banks - Role of Investment Banks - Investment bank researches

Investment bank researches and prepares a Prospectus for IPO (Initial Public Offering) containing all relevant financial data, business plan and P&L

markets the firm wishing to become a PLC to prospective investors

offers shares for sale in the Primary Capital Market

successfully enables market capitalisation or underwrites (insures) against a failed float

provides substantial funds for firms to invest (e.g. Arquiva £6bn)

increases productive capacity (LRAS to LRAS1)

long term economic growth.

Commercial and Investment Banks - Financial Crash 2008 (in a nutshell)

Insufficient regulation of (and increased interrelatedness of) financial markets coupled with inappropriate consumer borrowing and profligate bank lending

excessive risk taking

housing bubble

housing supply continued to increase whilst demand started to fall

bubble burst

increased failure rate of sub-prime mortgage repayments

information failure exacerbated via regulatory capture

collapse of trade in mortgage backed (and related) securities

credit crunch

global financial market contagion

widespread bank failures

uncertainty

higher unemployment

falling incomes

reduced real output

economic recession.

EVALUATIVE - Fall in income tax

Depends on which income group is affected (Keynesian consumption function) since have different marginal propensities to consume. Laffer curve.

EVALUATIVE - Fall in interest rates

Depends upon the extent of consumer confidence and level of firms expectations. Monetary policy is often a necessary but insufficient condition to affect change. Zero-lower bound. Liquidity trap.

EVALUATIVE - Fall in availability of credit

Affects big-ticket items e.g. houses and consumer durables bought on credit more than lower priced consumer goods.

EVALUATIVE - Increase in inflation

Unequal impact on the living standards of savers and borrowers. Ability to increase wages/income.

EVALUATIVE- Rise in savings ratio

Paradox of thrift - The basic concept is that if people save more in a recession, it will reduce consumption and thus aggregate demand will fall,

EVALUATIVE - Changes in G, I, X

Size of multiplier effect depends upon marginal tax rates, savings ratio and propensity to import.

EVALUATIVE - Changes in G

Depends on type of expenditure. Transfer payments do not affect AD. Capital spending increases LRAS whilst current spending may form deadweight debt if it requires an increase in the PSNCR.

EVALUATIVE - Changes in X-M

Depends on exchange rate, performance of trading partners, relative inflation rates.

EVALUATIVE - Changes in unemployment

Depends upon economic cycle, extent of SSPs, replacement ratio, unemployment trap.

EVALUATIVE - Changes in exchange rates

J-curve. Marshall-Lerner condition.

EVALUATIVE - Protectionist policies

Depends on PES of UK. Extent of retaliation by trading partners

EVALUATIVE - Increased G borrowing

Crowding-out depends upon the stage in the economic cycle.

EVALUATIVE - Benefits of specialisation and division of labour

Scope to achieve a fall in MC depends upon size of firm.

EVALUATIVE - Size of D-curve shift

Conditions of demand (closeness of substitutes and complements, size of income change, longevity and size of fashion, speed of population change).

EVALUATIVE - PED

Quantity and quality (closeness) of substitutes, timescale, % income, market width, necessity/luxury.

EVALUATIVE - Size of S-curve shift

Conditions of supply (size of production cost change, size of benefits of technological change, value of indirect tax and subsidy).

EVALUATIVE - PES

Timescale for growing agricultural goods, degree of spare capacity, stockpiles/inventories, factor mobility.

EVALUATIVE - Merit/Demerit goods

Subjective classification. Hard to accurately measure spill-over effects