Theme 2 PART 2

GDP

value of all goods and services produced in one year.

Year-on-year Growth

the percentage change between one year and the previous year.

Recession

Two consecutive quarters of negative GDP growth.

Gross National Product

The total value of all output produced by an economy in a given year.

Gross National Income

The total income earned by nationals of a country.

Nominal

not adjusted for inflation

Real

adjusted for inflation

Limitations of GDP

doesn't show- environmental degradation, non market transactions, wealth/income distribution, population size, PPP.

Purchasing Power Parity (PPP)

measure the total amount of goods and services that a single unit of a country’s currency can buy in another country

Purchasing power

value of a currency expressed in terms of the number of goods or services that one unit of money can buy.

Price level

measures the average price of a "basket of goods".

Inflation

an increase in prices/ fall in the value of money.

Index

used to compare values across years. Base year \= 100

Real

adjusted for inflation.

Nominal

not adjusted for inflation.

PPP

compares prices across countries to look at the true cost of living.

GNH

an index which is used to measure the collective happiness and well-being of a population (in Bhutan).

Limitations of CPI

-not all household consume all the basket of goods
eg single person households, four-children households, non-car owners, students, pensioners, rich, poor,
-quality of the product changes over time (e.g telephones)
-Basket of goods changes - but not fast enough.
-Data handling/ collection issues/ arithmetic vs geometric method.
-can't compare internationally

How is inflation measured?

Consumer Price Index (CPI)

How is CPI calculated?

Weights are set against a basket of 650+ goods, 'living costs and food survey' collects data from 7,000 households. CPI is the calculated relative to a base year.

Alternatives for CPI

RPI (includes housing costs)

Disinflation

Fall in price level, inflation \>0.

Deflation

Fall in price level below 0.

Hyperinflation

period of very high rates of inflation, leading to a loss of confidence in an economy's currency.

Problems with (Hyper)Inflation

-Erodes the value of money, savings & wages.
-Uncertainty leads to lower consumer and business confidence.
-Less internationally competitive so leads to fewer exports.
-Menu costs: the cost of changing price listings.

Problems with Deflation

-Discourages consumer spending: downwards spiral.
-Debt values increase in real terms. Borrowers worse off.

Causes of inflation

demand pull and cost push

demand-pull inflation

increases in the price level (inflation) resulting from increased pressure on existing FOP, increasing price of resources and COP, therefore increasing PL.

Factors that can cause demand pull inflation

- decrease in interest rates (cheaper to borrow, increased I+C)
-lower income/ cooperation tax (more disposable income/prices)
-increase GS
-weak exchange rate (exports cheap, imports dear, increases export revenue).
-wealth effect

cost-push inflation

When prices rise due to an increase in the cost of production.

Causes of Cost-pull inflation

-increased raw material prices
-increased wages
-increased indirect taxes
-currency depreciation

chain for why rising properties price causes inflation

rising property prices, wealth effect, more consumer confidence + more spending, demand pull inflation

chain for why increased global oil prices causes inflation

higher COP, passed onto consumers, cost pull inflation

Working age population

all those between the ages of 16-64 years.

Labour force

all those able and willing to work.

Employment

the proportion of the working-age population that is working.

Unemployment

the proportion of the working-age population that is actively seeking work but not working.

Underemployment

Employed but seeking more hours.

Two measures of unemployment

ILO LFS + Claimant counter

Pros/cons of JSA

+Easy, cheap and quick to collect
-excludes people that are actively seeking work but don't claim
-fraud could lead to overestimation
-not internationally comparable

Pros/cons of ILO LFS

+more accurate
+based on international standards
-more costly to compile
-only need to work one hour a week to count as employed

Types of Unemployment

-Seasonal unemployment
-Frictional unemployment
-Geographical unemployment
-Structural unemployment
-Real wage (classical) unemployment
-Cyclical (demand-deficient) unemployment

Seasonal Unemployment

unemployment caused by seasonal changes in the demand for certain kinds of labour

eg:
•Tourism
•Construction
•Post Office/ delivery workers
•Farming

Frictional Unemployment

A mismatch in information - the time involved in finding a new job.

•Search costs (internet!)
•Hiring/ firing policies & laws
•Worker dissatisfaction
•Interview process

Geographical Unemployment

A mismatch between the location of a worker and a job.

Vacancies in London (Jan 2020): 700,000
Unemployed in Scotland (Jan 2020): 105,000

Structural Unemployment

unemployment that occurs when workers' skills do not match the jobs that are available

Real wage (Classical) Unemployment

unemployment that results from wages being higher than the market-clearing level
causes: minimum wages, trade unions

Cyclical Unemployment

unemployment that rises during economic downturns and falls when the economy improves

How does unemployment impact workers?

-loss of income
-fall in living standards
-social/ psychological cost
-loss of skills
-less attractive to future employers

however, this forces workers to become more productive.

How does unemployment impact businesses?

- Fall in the demand for goods & services.
- Fall in demand further back along the supply chain.
- Decrease in profits.
- Redundancy/ downsize costs.

+ Larger surplus labour pool
+ Less pressure to increase wages
+ Reduced risk of industrial strike action

How does unemployment impact the government?

-Increase in welfare spending (income support, tax credits)

- Fall in tax revenue
•Income
•Corporation (profits)
•VAT (sales)

- Increase in government borrowing

How does unemployment impact the economy?

-Loss in GDP

-Under utilisation of factor inputs (productively inefficient)

What is the BOP made up of?

-Current account (X-M), Investment income, transfers
-Capital account
-Financial account

What are the 4 macroeconmic goals?

Low and stable inflation, low unemploymet, BOP, stable economic growth

What is the Current account made up of?

-trade in goods
-trade in services
-investment income (eg remmitances)
-transfers (eg EU payment fees, paying foriegn aid to developing countries)

What is the capital account made up of?

-debt forgiveness
-inheritance taxes

What is the finacial account made up of?

- portfolio investments e.g. bonds, shares and derivatives.
-FDI

What may worsen a current account deficit?

-strong domestic growth (incomes increase, M increases)
-recession overseas (overseas incomes decrease)
-strong ER (SPICED)
-High inflation

AD equation

AD \= C + I + G + (X-M)

Circular flow of income

a model of the economy which shows the flows of goods, services, factors of production and their payments.

National Income

Total value of money earned within an economy \= GDP.

Withdrawal/ Leakage

Taxes, Savings, Imports

Injections

GS, X, Investment

Consumption makes up about \_____ of overall GDP.

65% (2/3)

Factors affecting consumption

-consumer confidenct
-interest rates
-wealth effects
-animal spirits
-employment rates

animal spirits

psychological factors that lead to changes in the mood of consumers or businesses, thereby affecting consumption, investment, and GDP

Factors affecting investment

-rate econ growth (increased GDP, more capital needed to meet demand)
-confidence levels (confidence in tomorrow, more likely to invest today)
-intrest rates (low Intrest rates, cheaper to borrow)
-access to credit (easier to get a loan to invest)
-risk (low risk, more likely to invest)
-animal spirits

Fiscal budget surplus

TR\>GS

Fiscal budget defecit

TR

Factors causing a change in (X-M)

-increase in ER (spiced, X decreases)
-changes in real income (M increases)
-overseas recession (overseas income decrease, X decreases)
-protectionism (e.g tarrifs, quotas reduce X.)

Short run

At least one FOP is fixed

What causes a shift in SRAS?

changes in COP eg oil prices

What causes a shift in LRAS

changes in FOP (Capital, Enterprise, Land, Labour).

What is the difference between the kenysian vs classical LRAS?

Kenyesian model believes that in the long run an equilibrium can exist whilst an economy still has spare capacity.

Shifts in LRAS are caused by

changes in the quality/ quantity of FOP.
eg productivity, education, migration.

Firms provide households with...

Wages, rent, profits

Households provide firms with...

consumer expenditure

Increase in minimum wage shifts out...

AD and AS
AD- increased wages\= increase disposable income, AD increases due to increase C, demand pull-inflation.
AS increases due to increased COP,AS increases causing cost push inflation.

Appreciation of currency causes...

Increase in AS, decrease in AD.

AS cost of importing raw materials cheaper, SRAS increases. Cost push inflation.
AD imports become cheaper, exports dearer.

Increase in quality of education...

Eduation increases productivity, increase productive capacity, LRAS increases.
Education increases productivity, higher wages and spending AD increases.

MPC

change in C/change in Y

MPS

change in savings/ change in income

MPM

change in imports/ change in income

MPT

change in tax/ change in income

MPW

MPS+MPM+MPT or 1-MPC

Multipler equation

1/MPW or 1/1-MPC

Postive multiplier effect

Initial injection, AD increases causing a more than proportionate effect, further increasing output.
eg investment in infrastructure, increases AD, workers in the are consume, further shifting out AD.

Negative multipler effect

Initial withdrawl, AD decreases, Real output decrease, demand pull deflation.

Output Gap

a measure of the difference between actual output (Y) and potential output (Yf)

Negative Output Gap

Producing below trend. Spare capacity and unemployment present.

Positive Output Gap

Producing above trend. Growth is unsustainable and inflationary.

Negative output gap diagram

AD\> LRAS yfe

postive output gap diagram

Postive output gap reasoning

economic growth rate is greater than trend growth, occur during a boom. eg due to overtime.

eval- can cause inflation, may exhaust FOP + unsustainable in LR

Eval of output gap

hard to measure due to unkown quantity of:
unemployed workers,
worker,captial productivity,
spare capacity?

business cycle

Fluctuations in economic activity, such as employment and production

Monetary Policy

Involves using interest rates and other monetary tools to stabilise the economy.

MPC

The Monetary Policy Committee is a panel of experts who are responsible for setting Bank of England monetary policy.

Qualitative easing

creating new money electronically to buy assets (government/ corporate bonds).

Hot money

capital that investors regularly move between economies to profit from the highest rate of return.