Macroeconomics - Error Checklist

Index Numbers (2 marks)

A figure showing the % change in a variable relative to a base year (always 100).

Price Level (2 marks)

The average of current prices across the entire economy (e.g., measured by CPI).

Spare Capacity:

When an economy is operating below its potential (YFE), meaning there are unemployed factors of production (negative output gap).

ILO Unemployment:

Those without a job, want a job, have actively sought work in the last 4 weeks and are available to start in 2 weeks.

Hot Money Flow Transmission (Interest Rate > Exchange Rate)

Real-Wage Unemployment (Classical)

Net vs. Gross Investment (LRAS Evaluation)

If Investment (I) only equals Capital Depreciation (replacing worn-out machines), it is "Gross" but not "Net." Result: No shift in LRAS; productive potential stays the same.

Income Tax vs. Ad Valorem Tax

• Income Tax = Progressive/Direct tax on earnings (Reduces Inequality). Ad Valorem = Indirect tax as a % of price (VAT/Sugar tax). Never use them interchangeably.

Effectiveness of Demand-Side Policies (The Big 9)

1. Magnitude: Is 0.25% enough? 2. Confidence: If Animal Spirits are low, decreased Interest Rates won't stimulate borrowing. 3. Time Lags: 18–24 months for Monetary; "Recognition/Implementation" lags for Fiscal. 4. High leakages: demand-side policies less effective 5. MPC low > just save/import/tax 6. Bailouts (e.g. govt bought Lloyds Bank) > opp. cost, risk-taking 7. QE hoarded 8. Relative IR? 9. VAT vs income tax etc.? 10. Fixed mortgages 11. Banks may not lower IR

Why Brexit Uncertainty > IR should be low

Lower business confidence > lower I > lower consumer confidence + IR rise > further reduce discretionary income > widening negative output gap

Net transfers (definition)

Net value of unilateral (one-way) transfers of money between countries, where there is no corresponding exchange of a good or service

Component of current account (other than trade in goods/services & net transfers)

Income Balance: earnings from abroad (e.g., dividends, interest, and wages) minus payments made to foreign investors.

Government borrowing (definition)

G - T

Expansionary monetary policy = inflation: application?

1. QE usage: used in 2009-2012 when IR already 0.5%

2. Zimbabwe: Inflation peaked at 79.6 billion percent in 2008.

3. Weimar: a loaf of bread cost 250 marks in January and 200 billion marks by November 1923 (wheelbarrows used), workers paid twice a day

What does Phillips Curve show?

Unemployment falls > inflation rises (and vice versa)

Marginal Propensity to Consume/Withdraw

Proportion of extra income spent on (anything except) consumption

GNI (definition)

GDP + income abroad from residents - income earned by non-residents within country

Effectiveness of expansionary fiscal policy: application (2 points)?

• 2008: VAT cut by 2.5%

• 1933: 4-8% G

The 3 Links:

1. How to link contractionary policies to better BoP

2. How to link consumption to unemployment

3. How to link consumption/investment to BoP (apart from increased consumption of imports)

1. Lower income > fewer imports

2. Consumption > economic growth (output increases) > firms hire more workers to produce extra output > (increased derived demand for labour) > reduced cyclical unemployment

3. Less consumption/greater investment > lower AD/greater LRAS > lower PL > exports more price competitive

Disposable income

Adjusted for tax and welfare payments

Trade Deficit: Evaluation

1. Indicates high real disposable incomes/consumer confidence

2. Capital goods > LRAS shift

3. Funded by FDI/shares in UK companies/govt bonds + investor confidence remains > sustainable

4. UK purchasing more foreign currency than foreign countries purchasing £ > supply of £ increases > depreciation

5. Lower demand-pull inflation

6. Hard to measure productivity (particularly in the service sector)

Benefits of GDP as a measure of economic growth/living standards

1. Internationally/historically comparable (helps with evaluating past & determining future policies)

2. Simple to calculate

3. Reliable/objective

4. Regularly recorded

5. Allows govt to see if meeting objective of economic growth

6. Govt/businesses forecast expected economic growth

7. Best available

8. GDP per capita removes population bias

Unemployment:

1. Willing

2. Able

3. Available in next 2 weeks

4. Actively seeking

5. But out of work in last 4 weeks

Underemployment

Wanting to work longer hours OR workers not fully utilising skills

Employment

Working age + paid work

LFS vs CC Drawbacks

LFS:

• Sampling errors

• Cost

• Discouraged workers/carers/early retired/spouse dependants (not willing) > not counted even though “truly” unemployed

• Underemployed (1 hour a week = employed?!)

• Demographic inequality

CC:

• Recorded quarterly (compared to monthly for LFS)

• Hard to compare countries (different conditions to claim benefits/none at all)

• Pride/high assets or savings/spouse earning > illeligble & lower than LFS

• Fraud

• Discouraged workers/carers/early retired/spouse dependants (not willing) > not counted even though “truly” unemployed

• Conditions to apply may change > figure changes even if unemployment constant

Unemployment rate

(Unemployed / Labour force or Economically active) x 100

Demand-Side Policies to combat Inflation: Evaluation

1. Other objectives: Lower economic growth/unemployment

2. Lower investment > lower long-run economic growth/productivity/ competitiveness

3. Indebted living standards

4. Hot money flows

5. Ineffective against cost-push inflation

How QE works

1. Digital money created by BoE

2. Used to buy govt bonds from financial institutions

3. Price of govt bonds rises + fixed return on investment for bond purchasers > yield (IR) falls

Factor affecting net trade apart from protectionism/exchange rates/real incomes

Relative inflation (between UK and trading partners), inflation higher in UK > net trade decreases (and vice versa)

Why trade deficit bad

1. Domestic job losses/domestic firms out-competed

2. Supply-side shocks > investors lose confidence/trading partners stop exporting > excess demand > inflation

3. UK trades ownership of assets for consumer goods > profits sent to foreign owners > leakage/negative multiplier effect

Judgement (3 tips)

1. Rule of thumb: short-run > growth falls/detrimental, long-run > sustainable/necessary

2. Monetary or fiscal better?

3. Ultimately, the most significant effect is ...

Evaluating Expansionary Fiscal Policy

1. Demand-Pull Inflation

2. Trade Deficit (as consumption increases)

3. Budget Deficit, how will govt fund this?

4. Crowding Out: govt demands loanable funds > demand for funds increases (but supply is constant) > IR increases

5. X-Inefficiency (wasteful)

6. Time lags

7. High leakages > less effective

8. MPC low > just save/import/tax

9. Investment only to replace depreciation?

Evaluating Supply-Side Policies

1. No guarantee of success

2. (Opportunity) cost (mustn’t lower G on other areas)

3. Time lags

4. Negative stakeholder impacts (deregulation/labour market reforms)

5. Investment only to replace depreciation?

PPP

Exchange rate at which an identical basket of goods can be purchased in different countries taking into account different costs of living or rate at which currency must be converted to have same purchasing power in another country

Multiplier effect

Process whereby an injection leads to a more than proportionate increase in GDP

Net trade application?

UK exports e.g. financial services, UK imports e.g. citrus fruits

Assess the impact of a depreciation of the pound in relation to the US Dollar on the UK's net trade what does this mean?

How pound falls impacts net trade with US

CPI vs RPI

1. CPI official

2. CPI excludes housing costs e.g. mortgage payments/rents/council tax > smaller (but follows similar trend to RPI)

Costs and Benefits of Inflation (^ = 2.7% inflation)

Costs (* = use Zimbabme/Weimar for application):

1. Lower purchasing power

2. Erosion of savings > further lost purchasing power

3. Lower export competitiveness

4. *Wage-price spiral (employees ask for higher wages > higher CoP > higher PL etc.)

5. *Consumer-price spiral (consumers buy now before inflation)

6. ^Menu costs, show leather costs (inconveniene of managing/moving/investing money)

7. Fiscal drag (for consumers): higher tax bands

8. Inflationary noise (volatile) > low confidence

9. ^Hits lower-income households hardest (food & utilities)

10. ^IR rise to combat inflation

Benefits:

1. Firms can cut real wages instead of nominal wages > morale

2. Low/stable inflation > little effect on consumption (as it’s natural)

3. Firms can raise prices > revenue rise > output rise & can lower real wages instead of redundancies in recession > low unemployment

4. Reduced real value of debt

5. Fiscal drag (for govt)

Evaluation:

1. Rate

2. Cause: demand-pull better & easier to solve

3. Duration

4. Risk of spiral

5. Stability

Deflation - Causes and Consequences

Demand-Side Deflation:

• AD falls > lower growth/higher unemployment

• Long-term, anticipated (long-lasting)

• Spiral: real IR always positive (as cost of borrowing lower over time) > delayed spending (consumers wait until even cheaper) > profits/incomes fall > debt repayments harder (as fixed)

• Inflation at 0% > IR likely low > no room to lower IR if recession

Supply-Side Deflation:

• SRAS rises > higher growth/lower unemployment

• Short-term, unanticipated (short-lasting)

Direct tax

Tax on income/earnings and business profits

VAT

Ad valorem (percentage) indirect tax on businesses at each stage of production and distribution

Indirect tax

Tax on the production, expenditure and consumption of goods/services

Why UK’s GDP per capita at PPPs may increase slower than other countries

1. Population

2. Falling productivity

3. Net trade

4. Higher costs of living/inflation

5. Changes to calculation

6. Changes in value to US dollar used for calculations

Productivity

Output per unit of input

Market-led policies

Policies that focus on reducing the size of the state and in boosting the role of market forces in allocating scarce resources.

Aggregate Demand

1. Total planned spending (for goods and services)

2. At a given price level

Aggregate Supply

1. Total volume (of goods and services)

2. That producers are

3. Willing and

4. Able to produce

5. At a given price level

6. At any period of time

Evaluation: Migration > increased (Un)Employment

• Emigration?

• Agriculture/manufacturing boosted more

• Boom > high demand > excess supply of labour unlikely

Evaluation: productivity > less employment

• Compensation effect: price decreases as productivity increases > increased demand for labour

• May create new jobs

How supply-side policies less effective at lowering demand-pull inflation?

1. AS increase doesn’t matter if AD low

2. Time lags

Impact of falling real incomes in UK consumers: evaluation

1. Benefits/lower tax bands offsets fall

2. Short-term?

3. Falling inflation?

4. Better than redunancies

Is inflation risk concerning: evaluation

Spirals?, EG/incomes still rising, not widespread across economy, judgement

MPC success in controlling inflation

Yes:

1. 5% inflation > deflation fixed without stagflation

2. Independent of govt > IR not low for politics

3. Monthly meetings > can change course incrementally

4. Avoided deflationary spiral e.g. Japan

No:

1. Banking failure (more risk-averse)

2. Figure 2 frequently outside range

How deprec. = inflation

Cost-push via higher import prices

Exports impact on growth (eval.)

Small % of AD

How IR rise > disinflation

Mortgage repayments > housing demand/prices fall > NWE etc.

Minimum wage fall > SRAS rise

Benefits:

1. LRAS

2. Reduced export prices

Drawbacks:

1. Lower derived demand for labour

2. Increased poverty > benefits rise

3. Demotivation

4. Firms choose cheap labour over capital automation/R&D

• Depends on: wage elasticity of demand (firms may not hire more workers)

Keynesian (contractionary policy)

• Supply shortage > still at full employment

• However: time lag > policy doesn't affect until inflation gone & recession entered

Impacts of cheaper oil

KAA:

1. What sectors benefit most

2. Derived demand

Evaluation:

1. Less subsidy

2. Less oil firm revenue (& NWE for shareholders)

3. Lower investment in new oil exploration

4. Less renewables investment

5. Duration: sustained or due to price volatility?