IGCSE Economics: Government and the Economy

Definition of Economic Growth

An increase in the real output of an economy over a period of time, usually measured by the percentage change in Real GDP.

Gross Domestic Product (GDP) definition

The total monetary value of all final goods and services produced within a country's borders in a specific time period (typically one year).

Inflation distortion limitation of GDP

Nominal GDP can rise purely due to higher prices; Real GDP must be used instead to adjust for inflation and show true growth.

Population changes limitation of GDP

If the population grows faster than GDP, GDP per capita decreases, meaning individuals are worse off on average.

Hidden economy limitation of GDP

Unreported cash transactions, illegal activities, and home production are omitted, causing GDP to understate total economic activity.

Distribution and quality of life limitations of GDP

GDP does not show how income is distributed across the population and ignores negative externalities like pollution or loss of leisure time.

Characteristics of a Boom phase

High consumer spending, strong business investment/confidence, high economic growth, low unemployment, and rising inflationary pressures.

Characteristics of a Downturn phase

Economic growth begins to slow down, consumer and business confidence drops, and trade balances may weaken.

Recession technical definition and features

Two consecutive quarters of negative economic growth, characterized by falling GDP, business closures, high unemployment, and low inflation.

Characteristics of a Recovery phase

The economy picks up, investment rises slowly, consumer confidence returns, and GDP begins to grow again.

Positive impacts of Economic Growth

Creates more jobs (reducing cyclical unemployment), raises average incomes/standards of living, and increases tax revenue to reduce poverty.

Negative impacts of Economic Growth

Can lead to rapid demand-pull inflation if demand outstrips supply, and often increases industrial pollution and resource depletion.

Definition of Inflation

A sustained increase in the general price level of goods and services in an economy over a period of time, which erodes the purchasing power of money.

Definition of Deflation

A sustained decrease in the general price level of goods and services (negative inflation rate).

How the Consumer Price Index (CPI) measures inflation

Measures the average change in prices paid by consumers over time

Definition and cause of Demand-Pull Inflation

Inflation triggered when total aggregate demand exceeds the economy's capacity to produce goods and services ("too much money chasing too few goods").

Definition and cause of Cost-Push Inflation

Inflation triggered when production costs rise (e.g., higher wages or raw material prices), forcing firms to raise prices to protect profit margins.

Operational relationship between inflation and interest rates

Inverse operational relationship; central banks raise interest rates to discourage borrowing and spending, which cools down demand-pull inflation.

Impact of inflation on exports

Domestically produced goods become less price-competitive abroad, causing national export volumes to fall.

Definition of Menu Costs

The physical cost and time required for firms to constantly change catalogs, price tags, price digital systems, and menus during inflationary periods.

Definition of Shoe Leather Costs

The time and effort consumers spend searching for the best prices or moving money between accounts to protect its value from eroding.

Impact of inflation on confidence and investment

Uncertainty over volatile prices causes consumer and business confidence to plummet, leading households to hoard savings and firms to freeze investment.

Definition of Unemployment

A situation where individuals who are able and willing to work, and actively seeking employment, cannot find a job.

International Labour Organization (ILO) measurement of unemployment

A survey method counting anyone without a job who has actively sought work in the last 4 weeks and is available to start within 2 weeks.

Cyclical (Demand-Deficient) Unemployment

Unemployment caused by a lack of aggregate demand in the economy during a recession or economic downturn.

Structural Unemployment

Unemployment caused by a mismatch between workers' skills and the skills required for vacant jobs, often due to industrial decline or automation.

Seasonal Unemployment

Regular, predictable job losses that occur at specific times of the year, such as in tourism, skiing, or agriculture.

Voluntary Unemployment

Unemployment that occurs when workers choose not to accept a job at the prevailing market wage rate.

Frictional Unemployment

Short-term unemployment experienced when people are temporarily "between jobs" or entering the workforce for the first time.

Economic impacts of high unemployment

Lost national output (GDP operating inside its PPF), wasted scarce labor resources, lower income tax revenue, and higher government spending on benefits.

Social impacts of high unemployment

Increased financial hardship/poverty, lower consumer and business confidence, regional decline, and rising social issues like crime and mental health challenges.

Current Account of the Balance of Payments

A record of a country's net trade in goods (visibles) and services (invisibles), net primary income, and net secondary income transfers.

Current Account Deficit vs. Surplus

A deficit occurs when import value and financial outflows exceed export value and inflows; a surplus is the exact opposite.

Visible vs. Invisible trade

Visibles are physical, tangible products (e.g., cars, oil); invisibles are intangible activities (e.g., banking, tourism).

Relationship between a current account deficit and exchange rates

Selling domestic currency to buy imports can depreciate the exchange rate, which eventually makes exports cheaper and imports dearer (SPICED), helping correct the deficit.

Structural reasons for a current account deficit

Domestic goods having inferior quality/innovation compared to foreign goods, higher domestic production costs making prices uncompetitive, or a persistently overvalued currency.

Key impacts of a persistent current account deficit

Money leaks from the domestic circular flow (reducing AD), risks cost-push inflation if essential imports are pricey, causes structural unemployment, and depletes foreign reserves.

Four ways businesses damage the environment

Visual pollution (litter, factory scars), noise pollution (machinery, heavy transport), air pollution (greenhouse gases), and water pollution (chemical waste dumping).

Government market interventions to protect the environment

Taxation (carbon taxes), subsidies for clean industries, strict legal regulations, financial fines for violations, tradable pollution permits, and public provision of parks.

How a Pollution Permit (Cap and Trade) system works

The government sets a total emissions cap and issues legal permits; clean firms can sell their surplus permits to polluting firms, creating a financial incentive to go green.

Income Inequality vs. Absolute Poverty vs. Relative Poverty

Inequality is the unequal spread of income; absolute poverty is lacking basic survival needs (food, shelter); relative poverty is earning significantly less than the national average.

Three reasons governments reduce poverty and inequality

To ensure citizens can meet basic survival needs, to raise general standards of living/productivity, and for ethical reasons of fairness and social cohesion.

Three core government interventions to redistribute income

Progressive taxation (higher tax rates for high earners), welfare benefit payments (unemployment/pensions), and state investment in free education and healthcare.

Definition of Fiscal Policy

The configuration of government revenue (taxation) and government expenditure (spending) to influence the level of aggregate demand and economic activity.

Direct vs. Indirect Taxes

Direct taxes are levied straight on income, wealth, or profit (e.g., Income Tax); indirect taxes are levied on spending on goods and services (e.g., VAT).

Fiscal Deficit vs. Fiscal Surplus

A deficit occurs when Government Spending (G) is greater than Tax Revenue (T); a surplus occurs when Tax Revenue (T) is greater than Government Spending (G).

Expansionary vs. Contractionary Fiscal Policy application

Expansionary (G > T) boosts aggregate demand to cut recessionary unemployment; Contractionary (T > G) cuts aggregate demand to cool down high inflation.

Definition of Monetary Policy

Central bank actions that manipulate interest rates and the money supply to control aggregate demand and achieve inflation stability.

Transmission mechanism of an interest rate hike

Higher rates make borrowing expensive and saving attractive -> mortgage repayments rise -> disposable income falls -> consumer spending and business investment drop -> AD and inflation fall.

Asset Purchasing (Quantitative Easing - QE)

When a central bank creates electronic money to buy government bonds from commercial banks, increasing financial liquidity and lowering lending rates to stimulate economic growth.

Definition and aim of Supply-Side Policy

Government measures designed to increase the productive capacity (Aggregate Supply) of the economy by improving the efficiency and performance of markets.

Graphic impact of successful supply-side policies

They shift the Long-Run Aggregate Supply (LRAS) curve to the right, expanding the maximum potential output of the economy without causing inflation.

List of key supply-side policy actions

Privatisation, deregulation, education/training investment, regional development incentives, infrastructure spending, and lowering business/income tax rates.

Trade-off of using Regulation and Legislation

Provides clear legal boundaries and can ban harmful products, but it is expensive to police and increases business compliance costs, hurting competitiveness.

Trade-off of using Fines for environmental control

Acts as a financial deterrent and raises immediate revenue, but highly profitable firms may treat them as a "cost of doing business," and violations are hard to prove.

Trade-off of using Pollution Permits

Puts a strict market cap on total national emissions and rewards green technology, but it is difficult to allocate the initial number of permits, and rich firms can buy them out.

The conflict between Unemployment and Inflation

Expansionary policies to lower unemployment boost AD, creating wage pressures and shortages that trigger inflation; contractionary policies to curb inflation reduce demand and raise unemployment.

The conflict between Economic Growth and Environmental Protection

Scaling up production to increase GDP causes factories to burn more fossil fuels and extract resources aggressively, causing higher pollution and environmental degradation.

The conflict between Inflation and the Current Account Balance

High domestic inflation makes domestic goods expensive, causing foreign buyers to stop purchasing exports and domestic consumers to buy cheaper foreign imports, widening the deficit.