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Economics AS Level Work Module 2
Economics AS Level Work Module 2
13/3/08
MODULE 2 – the national economy
Creation of wealth is a key factor and we must be able to measure the income
and wealth.
Income = flow
Wealth = is a stock. Static.
If you have wealth, you can use the wealth to create income.
If you have a high income you can accumulate wealth.
-2. Expenditure method - care must be taken not to double count – purchases
included are for final consumption. Taxes deducted. Subsidies added.
-3. Income measure – The value of all incomes are added together to include
wages from employment, Profits and rents. Transfer payments not counted.
Welfare benefits.
EQAULISING the three methods – all three methods should give the same
calculation. We assume for instance that all goods and services created will be
sold. Every time a good is sold this will create income for all those involved in
making the good.
So NATIONAL OUTPUT = NATIONAL EXPENDITURE = NATIONAL INCOME
GDP – Gross Domestic Product (what is produced in the UK, never mind
who owns the businesses, and makes no allowance for replacement)
GNP – Gross National Product (value of UK output factors owned in UK)
NDP - Net domestic product (GDP – replacement goods)
Index numbers – valuable at a glance e.g. price rises from £403.57 to £432.41
Index is 100% - 107.04%
National income (NY) and living standards – The income of India is greater than
the national income of Norway. Physical living standards = national
income per head
And national income per head = national income / population.
For many people it’s not just about material possessions.
These are about living standards: The air we breathe, crime rate, landscape,
cultural factors, life expectancy, leisure time.
Balance of Payments -
Britain is a great trading nation. We import and export about a third of our GDP.
In America it is only about 14% instead of 33%.
Visible Trade Account – Money flows in as we export GOODS and money flows
out as we pay for the GOODS we import. More money is flowing out of the
country faster that it is flowing in because we tend to import more goods that
we export, in money terms.
Invisible Account – Out flow and inflow of trades and services. This includes
Banking, insurance. The invisible account records the payment for imports and
exports of countries services. If an American account employs a British firm for
insurance we bring in money. If a British firm employs an American insurance
company then the money flows out. Also recorded on this accounts are
INTEREST, DIVIDENDS and PROFITS. On balance we are on surplus on this
account. In other words we receive more money than we spend out.
Current Account (Balance of Payments on Current Account) - The Economics
Glossary defines the Current Account as the difference between a country's
savings and its investment. "If the current account balance is positive, it
measures the portion of a country's saving invested abroad; if negative, the
portion of domestic investment financed by foreigners' savings."
Visible account + Invisible Account -
The capital Account also records money transfers. E.g. if a British person of
Jamaican origin sends money to relative in the West Indies this will be an
outflow on the capital account.
Measuring Unemployment -
It used to be done by the claimant count, i.e. the number drawing
unemployment benefit now called job seekers allowance. However many
people might have been looking for a job but were not included in the figures
because they were not entitled to benefit. The favoured measure now is the
Labour Force survey which is now better for international
Types of Unemployment -
1. Cyclical Unemployment – due to deficiency of demand, not buying or
spending enough. We associate this with a recession.
2. Structural Unemployment – more likely due to change in demand. E.g.
people that had jobs in summer activities, selling deck chairs or ice creams etc.
3. Technological – the miracle of the word processor, a person on a word
processor is at least 3 times more productive than one amazing secretary on a
type writer. With the introduction of word processors a lot of secretaries lost
their jobs as there was no need for 3 secretaries when just one person could do
the work. It is one of the major reasons for the distribution of wealth.
4. Regional – people are geographically immobile.
5. Casual and seasonal – Seasonal – depends on the season as whether you
get a job, summer jobs. Casual – where you never know whether you have a
job. You could have a job-for-a-day then not have a job for a month.
6. Frictional / Transitional = people between jobs. The well qualified might
stay unemployed until a better job comes into the market.
7. Other types – a. Low incentives, disposable income out of work / disposable
income in work.
b. Hysteresis - Where capacity is permanently lost e.g. de-
industrialisation. Workers who lost their jobs in such industries are likely to stay
long-term unemployed.
c. Insider/Outsider theory – force up wages for members
(Insiders)
d. Queuing – this is the theory that people will not take the low
paid jobs and wait for a better job to come along.
Employment -
UK rise in the number of jobs available over the last few years. There has been
a bit of controversy over immigrants taking jobs. It is the quality of the jobs.
Many of the jobs immigrants take are not requiring as much skill. Incapacity
benefit.
Costs of Unemployment -
Economic Costs - Wastes of resources
Social Costs - is the standard of living.
Deflation -
- Opposite to inflation – in general terms this means that prices of goods are
falling.
Firms don’t favour deflation because they don’t like selling goods for low prices
BUT
- Deflation is nearly always accompanied by a RECCESSION. Why? This is
because
High level of AMD you don’t have a high employment.
- The real aim is sustained non-inflationary growth.
Monetary Policy C (MPC) – decides the interest rates, which is run by the
bank of England.
Monetary policy is used to slow down or re-inflate the economy.
Nationallythere are 0.8 million people claiming job seekers allowance. 2.5
million are claiming incapacity benefit.
• Environment
• Redistribution
Economic Growth
Increase in productive capacity and rise in GDP.
This means there is an increase in output therefore creating an increase of
capital.
PPC is moved to the right.
The output gap – in the short term NY may increase without real economic
growth simply
byemploying idle resources thus closing this negative output gap.
In a boom resources may be over employed (e.g. excessive over-time that
cannot be sustained) meaning the economy is operating beyond is potential
output (positive output gap).
True economic growth requires an increase in productive capacity.
Country X -
Date National Income Inflation Rise
2006 2000 billion 5%
2007 2200 billion 10%
Questions
1. List the government’s targets in respect of reducing incapacity benefit
and lone parent benefits.
a. The government hopes to lure 1,000,000 of the 2.6 million claiming
incapacity benefit and 300,000 of the 760,000 people claiming lone
parent benefit back to work.
2. What actions is the government considering?
a. They will impose skill checks, training and subsidised
apprenticeships.
3. What is considered to be the main cause of so many on benefits?
a. Poor skills, laziness, hopelessness, low expectations and benefit
traps.
4. What actions might the opposition take if given the opportunity?
a. They propose sanctions for claimants who refuse job opportunities,
extra screening for people claiming incapacity benefits and
compulsory community work for the long term unemployed.
5. How has the makeup of in capacity benefit claimants changed over recent
years?
a. ??
6. How does America Works encourage rehabilitation?
a. ??
7. Why might British employers fail to respond to inflation?
a. ??
The Trade Cycle -
The UK has experience over 15 years of continuous economic growth which is
unprecedented since the Second World War. This does not mean however that
future growth is guaranteed.
The old stop go recoveries means that boom should only last 3 or 4 years but
we have been in a record 16 year BOOM.
Comparisons
The shape of the Ag Demand slope – The reason the curve slope downwards is
because we expect National income to rise as the price level falls and vice
versa.
For example – if a household is on a reasonably fixed income (most are), then a
rise in prices means that fewer goods and services can be brought than before.
The higher the price level the less can be afforded.
Keynesian economists argue for a steep curve, i.e. changes in the price level
have only a slight effect on National Income. Classical economists argue the
opposite.
Another argument is the way in which a rise in the price level affects the
consumption through the wealth effect e.g. people have savings. If the price
rises you won’t get as much for your money. To restore the value of your money
you have to save more and spend less. If you now save 20% of your income
instead of 10% you will have 10% less to spend – CONSUMPTION FALLS.
Shifts in the AD –
Shifts in the AD curve will occur if there is a change in any relevant variables
other than the price level. There are a number of such variables for example
any of the following might shift the curve to the right – from AD to AD1
1. Consumption -
a) A fall in unemployment.
b) MPC – monetary policies committee reduces interest rates- note this is a
fall in interest rates NOT as a result of lower prices which concerns
movement along the curve.
c) A rise in the value of the stock market increasing consumer wealth.
d) A change in the age distribution.
e) New technology with wonderful must buy products.
f) A fall in income tax increasing disposable income.
Of course the above in reverse would shift the AD curve to the left. Making
AD2.
2. Investment –
a) Lower interest rates
b) Increase in business confidence
c) Cut in consumption tax
3. Government spending –
a) E.g. taking children out of poverty
4. Exports –
a) An increase in revenue
b) Fall in the £
The Multiplier – the idea of the multiplier is that any injection in to the economy
will lead to a greater increase in national income/national output.
e.g. firms make an investment if £10M for making a new road. Then from the
£10M, £2M will be saved and £8M will be spent by builders etc. This process
continues to happen as around 1/5 is saved and 4/5 is spent on other firms e.g.
Cadburys.
Aggregate supply –
The aggregate supply curve shows the level of output in the whole economy at
any given level of average prices. We will consider both the shirt run and the
long run aggregate supply curves.
Short run aggregate supply curve – (SRAS) – The short run is defined as the
period when money wage rates and other factor inputs in are fixed in the
economy. Thus if we assume that if firms wish to increase output they are
unlikely to take in extra workers because of all the admin costs (e.g.
regulations) But will respond to the extra orders in the short run by giving their
workers overtime and working their resources harder.
e.g. 100 blodgets a week
110 blodgets a week
This may however add to costs since overtime rate have to be payed and tired
workers may be less productive. To meet these higher costs firms will raise
prices. Such price rises are likely to be modest so the SRAS curve tends to be
The LRAS curve shows what the economy can produce with all factors fully
employed.
The LRAS curve may shift to the right under the following circumstances –
1) More and better capital equipment – infrastructure, technology.
2) Better education and training this raises productivity.
3) Incentives to work harder (financial awards), to investments, to be mobile
etc.
Most governments try to encourage increase productivity, which will enable an
increase in output and therefore living:
Equilibrium output –
The economy is in equilibrium when aggregate demand equals aggregate
supply:
1.
The level of natural income we predict will settle at Y1 at price level 0P given
the situation above (SRAS and SRAD cross at same point). However this may be
a level of national income with unemployment and other resources idle.
2.
If in the short run there are idle resources real national output might be
increased with an increase with a level of aggregate demand. (see later notes
on fiscal and monetary policy). This may lead to some increase in the price
level.
3.
If all resources are fully employed (full employment level of national income
illustrated by vertical LRAS curve) then any increases in aggregate demand will
only lead to an increase of price level.
4.
National income can be increased in real terms if the productive capacity of the
economy can be increased, i.e. if the LRAS curve can be shifted to the right.
Recap multiplier – the multiplier suggests that any increase in national income
will have a multiplying effect e.g. government spending £10M on a new hospital
may lead to the creation of £20M addition income.
Monetary Policy
This is concerned with controlling the supply of money in an economy with
particular concern about its effect on AD and AS.
Thus a rise in interest rates will be disinflationary and will cut the level of
imports, helping the balance of payments deficit. UK has high MPM (Marginal
Propensity to Import).
If the problem appears to be rising unemployment, a slowdown in growth, then
providing inflation is under control, one would expect the MPC to cut interest
rates.
Note of course the economy can only grow in real terms if there are idle
resources.
Clearly if the above can be achieved, the UK economy will produce more goods
and services (economic growth), become more competitive (reduce B of P
deficit), create more jobs (lower unemployment) and allow AD to expand
without inflation. In other words achieve that supreme goal of sustained non-
inflationary growth.