Theme 2 Key Terms

Economic Objectives

Sustainable economic growth; low unemployment; low and stable inflation; a satisfactory position on the balance of payments; a balanced government budget; an equitable distribution of income; environmental sustainability

GDP (Gross Domestic Product)

The total market value of all goods and services produced over a period of time

GNI (Gross National Income)

GDP + net income from abroad

Income

The rewards to the factors of production, is used to buy goods and services

AD (Aggregate Demand)

Consumption + Investment + Government Spending + Net Exports

Demand

The quantity of goods and services that consumers are willing and able to purchase at a certain price over a period of time

Price Level

Average level of prices in the economy

Consumption

The spending by households on goods and services

Investment

The spending on goods by firms in order to produce more goods or services

Supply

The quantity of goods that sellers are prepared to sell at any given price over a period of time

The multiplier effect

When an increase in investment or other injections lead to an even greater increase in income

Injections into the circular flow of income

Exports, Government Spending, Investment

Leakages in the circular flow of income

Imports, Taxes, Savings

MPC

Marginal Propensity to Consume

MPS

Marginal Propensity to Save

MPM

Marginal Propensity to Import

MPT

Marginal Propensity to Tax

MPW

Marginal Propensity to Withdraw (MPS + MPM + MPT)

MPC + MPS + MPM + MPT = ?

1

First formula for calculating the multiplier

1 ÷ (1-MPC)

Second formula for calculating the multiplier

1 ÷ MPW

Purchasing Power Parities

An exchange rate of one currency for another which compares how much a typical basket of goods in one country compares to that of another country

Actual Economic Growth

The growth in the quantity of goods and services produced measured by the percentage change in GDP

Potential Economic Growth

The change in the productive potential of an economy over time

Unemployment

When people who are willing and able to work between the ages of 16-64 do not have a job

The level of unemployment

The number of unemployed people

The labour force

All the people willing and able to work

The rate of unemployment

(the level of unemployment ÷ the labour force) x 100

Keynesian Full Employment

When 3% or less of the labour force is unemployed

Free-market Full Employment

When all those who are willing and able to work at the going wage rate have a job

The Claimant Count

The number of unemployed is the number of people claiming Job Seekers’ Allowance (JSA)

The Labour Force Survey

A quarterly sample of 60,000 households in the UK, where unemployed people must have been looking to work in the past 4 weeks and that can start in 2 weeks

Cyclical Unemployment

Occurs when AD falls

Frictional Unemployment

Short-term unemployment associated with job search

Structural Unemployment

Long-term unemployment, occurs when demand for labour is less than its supply in an individual labour market

Real-Wage Unemployment

When real wage rates are above the equilibrium real wage rate

Seasonal Unemployment

When workers are laid off on a short-term basis in particular industries at certain times of the year

Inflation

A sustained rise in the price level over a period of time

Disinflation

When the rate of inflation is falling but is still positive

Deflation

A sustained fall in the price level over a period of time

Consumer Prices Index (CPI)

A weighted average price index that measures the changes in the price of a basket of representative consumer goods over a period of one year

Annual CPI inflation rate

( (Current year CPI - Previous year CPI) ÷ Previous year CPI) x 100

Demand-pull inflation

When an increase in AD leads to an increase in the price level

Cost-push inflation

When a decrease in AS leads to an increase in the price level

The Balance of Payments

A record of all financial transactions between one country and other countries

Components of the Balance of Payments

The current account; the financial account; the capital account

Components of the Current Account

The trade balance; primary income flows; secondary income flows

Components of the financial account

Net foreign direct investment; net portfolio investment; other capital flows; drawings on reserves

Components of the capital account

transfers of physical capital between countries

Trade deficit

When the monetary value of exports is less than the monetary value of imports in a given period of time

Trade surplus

When the monetary value of exports is more than the monetary value of imports in a given period of time

Monetary policy

A demand-side policy involving the use of the interest rate, the availability of credit, the money supply and the exchange rate to influence AD and, therefore, real national output, employment and the price level

The Bank Rate (interest rate)

The minimum rate charged by the Bank of England when lending to commercial banks

Expansionary monetary policy

Decreasing the interest rate and/or increasing the availability of credit and/or increasing the money supply to increase AD

Contractionary monetary policy

Increasing the interest rate and/or decreasing the availability of credit and/or decreasing the money supply to decrease AD

Quantitative Easing

Used as an expansionary monetary policy, increases the supply of money and the demand for loans

Fiscal Policy

Involves the use of taxation and government spending to achieve macroeconomic objectives

Expansionary fiscal policy

Increased government spending and decreased tax (budget deficit) to increase AD

Contractionary fiscal policy

Decreased government spending and increased tax (budget surplus) to decrease AD

The cyclical component of a budget deficit

The part of the deficit which rises and falls with the economic cycle

The structural component of a budget deficit

The part of the deficit that results from a government’s policy choice to spend more than its tax revenue

Financial crowding out (from expansionary fiscal policies)

Increased government spending can be financed by taxation or borrowing, which reduces consumption and investment

Free-market resource crowding out (from expansionary fiscal policies)

Employing factors of production in the public sector is likely to prove less efficient than in the private sector

Keynesian resource crowding out (from expansionary fiscal policies)

Resource crowding out should not arise if there is spare capacity in the economy when increased government spending leads to crowding in of the private sector

Components of government spending

Current expenditure; capital expenditure; transfer payments; debt interest

The Budget

Is the government’s annual statement on taxation and government borrowing

Direct tax

A tax on income, profit or wealth that cannot be shifted by the party liable for the tax onto somebody else

Indirect tax

A tax on expenditure on goods and services that can potentially be shifted by the party liable for the tax onto somebody else

Progressive tax

As income rises, a higher proportion of income is paid in tax

Regressive tax

As income rises, a lower proportion of income is paid in tax

Proportional tax

As income rises, the same proportion of income is paid in tax

Supply-Side Policies

Policies that aim to increase the productive capacity and international competitiveness of the economy by increasing the quantity and quality of factors of production

Market-based supply-side policies

Designed to remove barriers to the efficient working of free markets (free-market economists)

Interventionist supply-side policies

Designed to correct market failure (Keynesian economists)