Government Economic Policy Objectives:

What are the benefits of economic growth?

• Increased demand for labour → fall in unemployment+higher wages

• Higher wages can increase standard of living

• Firms earn greater profits → investment → improves the economies productive potential

• Likely firms will produce more, improving balance of payments

• Tax revenue rises, benefits decrease → improves governments fiscal position

• May sour more investment in environmental sustainability

What are the costs of economic growth?

• Worsen income inequality

• Reduced productivity from more stress at work

• Demand-pull inflation

• Imports of luxury goods may increase, worsening balance of payments

• Negative externalities form industrial expansion

• Tragedy of the commons

• Finite resources may be used up too quickly

How can you create long run economic growth?

• Innovation

• Improving capital stock

• Raised agricultural output via genetically modified crops

• Improve human capital (education/training)

• Increasing the size of the working population (immigration)

Examples of demand-side shocks:

• Consumer confidence is boosted eg house prices rising

• If a countries major trading partners go into recessions, reduced demand for the country’s exports

Examples of supply-side shocks:

• A poor harvest would reduce the supply of food, increasing prices, and reduces the economy’s capacity

• The discovery of a major new source of a raw material will reduce its price and increase supply, increasing the capacity of the economy

Features of sustainable growth:

• Expand output every year

• Continuous supply of raw materials/land/labour

• Find growing markets for the increased output

• Reduce negative externalities

Why do governments want full employment?

• Maximised production

• Raises living standards

When does occupational immobility occur?

When workers don’t have the skills to do jobs that are available, and their industry has shrunk

What is geographical immobility?

Where workers aren’t able to leave a region to seek work elsewhere (family ties, costs)

What factors cause cost-push inflation?

• A rise in wages above any increases in productivity

• A rise in the cost of imported raw materials

• A rise in indirect taxes

What factors cause a rise in demand-pull inflation?

• High consumer spending or demand for exports

• The money supply growing faster than output

• Bottleneck shortages, if demand grows quickly when labour and resources are already being fully used then increasing output may lead to shortages (positive output gap) where prices rise and costs increase

What is the Fisher’s Equation of Exchange?

The quantity theory of money:

money supply (M) x velocity of money (V) = price level (P) x total amount of transactions in the economy (Q)

SR V and Q unlikely to change so M=P

Good theory for high levels of inflation

What are the costs/consequences of inflation?

• Falling standard of living

• Competitiveness reduced

• Discourages saving → shortage of funds for borrowing and investment

• If I.R increase, investment reduces

• Creates uncertainty for firms

Why might a country experience a current account deficit?

• High levels of consumer spending (increase in imports)

• Struggling to compete internationally (reduction of exports)

• When it has to deal with external shocks

Why might a country experience a current account surplus?

• Experiencing a recession, can’t sell products domestically, so focus on increasing exports

• Domestic currency low value

• High interest rates, more saving less spending

What are the consequences of a balance of payments deficit?

• Indicates an uncompetitive economy

• Could mean people are wealthy enough for expensive imports → high standard of living

• Fall in a value of currency, inflation

• Domestic job losses

Consequences of a balance of payments surplus?

• Indicates a competitive economy

• Stagnation

• Low/negative economic growth, unemployment

• May be the result of another countries over reliance on exports

• If created by an undervalued currency, inflationary pressures are created

How can a government try to correct a BOP deficit?

• Policies to reduce the price of domestic goods

• Restrictions of imports (quotas, tariffs)

• Depreciate the currency

• Fiscal/monetary policy to reduce spending in the economy

How can a government try to correct a BOP surplus?

Raise the value of the currency, will reduce demand for exports and increase demand for imports, may lead to reduced output/unemployment

What is the capital accout?

Includes transfers of non-monetary and fixed assets (immigrants and emigrants their assets become part of the UK’s total assets)

What is the financial account?

The movement of financial assets inc:

• FDI

• Portfolio investment, overseas shares

• Financial derivatives, contracts whose value is based on the value of an asset eg a foreign currency

• Reserve assets, financial assets held by the BofE to be used as and when needed

What are other economic policy objectives?

• Income redistribution

• Protect the environment

• Economic stability

• Improve productivity

Demand-side policies to reduce cyclical unemployment+downsides:

• Reflationary fiscal policies, lower taxes

• Expansionary monetary policies, lower IR

• Lack of information about the multiplier or output gap can lead to the government doing too much and inflation increasing too quickly from AD

• Time lags

Why do monetarists argue theres no trade-off between inflation and unemploymet?

Long run there is a return to NRU

What factors determine the flexibility of labour?

• Labour mobility

• Wage flexibility

• Flexibility of working arrangements

What factors affect the distribution of income?

• People earn different wages based on their skills

• Unwaged people often rely on state benefits so their incomes are lower

• tax and state benefits

• What sector people work in

• Regional disparities

How can you calculate the gini-coefficient?

A/(A+B)

WHat do the values of the gini-coefficient mean?

0=complete equality

1=complete inequality

What is horizontal equity?

People with the same circumstances are treated fairly (the same)

What is vertical equity?

People with different circumstances are treated fairly but differently

What are the negatives of an unequal distribution of wealth and income?

• Absolute and relative poverty remain high

• Restricts economic growth and wastes talent

• Spending on imports increase, money leaves the circular flow

• Social impacts

  • Poor health

  • More crime

  • Lower levels of wellbeing

What are the positives of an unequal distribution of wealth and income?

• Lower earners may feel if they work harder they can achieve a higher income, increases productivity

• Incentive for people to start their own businesses

• Higher incomes for richer people may encourage them to invest more

  • This creates jobs

  • Stimulates trickle-down effect

How might governments intervene to alleviate poverty?

• Benefits

  • Redistribute income

  • Contribute to poverty trap

• Sate provision eg NHS

• Progressive taxation

• Economic growth

• NMW