Mustafa Ramji ECON2

Understand how economic growth is measured…

Actual growth is an increase in real incomes (GDP), whilst potential growth is the increase in productive capacity
in an economy.
Real values adjusted to remove effects of inflation, whilst nominal values have not.
GDP – output method – add up value of goods/ services produced in economy
- Income method – measures value of all incomes earned in economy
- Expenditure – total spending on goods and services in economy
Must be measured ‘per capita’ is better way of measuring standards of living, as measuring total national income
does not account for population size etc. Importance of values not volumes.

…its limitations, for example: the inadequacy of economic growth measurement as a measure of standards of living,
problems of comparison between developed and developing countries.
Growth does not mean better SOL, as may be working more hours, social costs such as pollution
Subsistence, barter and black economy - farmers consuming own goods, goods traded without price system and
illegal markets
Currency values – purchasing power of currency varies between countries
Does not measure income distribution, simply average earnings
If public spending is great, it may not improve the welfare of the population
If spending is greater on capital goods, rather than consumer spending, SOL does not improve in the short term
Spending may not lead to quality

Understand the process of calculating the rate of inflation in the UK.

Inflation is the sustained rise in the general price level. Increases in the cost of living are measured using an index
based on a weighted basket of goods and services. A price survey and a family expenditure survey are used. The
index is called Consumer Price Index. It is measured monthly, and the goods can change yearly. A price index is
created, and the monthly price changes are measured.

Understand the significance of the measure.

If too low, people will put off spending until prices start falling and are very low. If too high, people cannot afford.
BoE aim is 2% + 1% inflation, using CPI.
CPI excludes housing costs, Retail PI includes housing costs.
CPI only measures average, not pensioners and highest bracket. Only 57% of households respond. Basket of goods
can only change once a year, but tastes change quicker. Unrepresentative of those with atypical spending
patterns. Value and quality of goods may change over a year.

Understand how unemployment is measured in the UK.

Workforce are those who are at work, of working age, willing and able to work (employed + unemployed)
International Labour Organisation Unemployment def.: people of working age who are without work and actively
seeking work” – Labour Force Survey
Claimant count – those who are out of work and seeking JSA, below ILO as may not claim (under 18, stigma and
short term unemployment)

Understand the types of unemployment.

Cyclical – unemployment due to insufficient AD
Structural – unemployed due to lack of skills for available jobs
Frictional – temporarily unemployed because even though job exists
Seasonal – unemployed temporarily as businesses do not have much demand in some times of the year

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Understand the costs of unemployment.
Cost to economy - SR - production lost
- LR – lower growth, loss of skills and motivation, structural unemployment
Cost to society – anti-social behaviour and crime
Cost to government – lost tax revenue, high spending on JSA and benefits
Cost to individual – decreased income, loss of status and self- confidence, loss of skills
 Lower inflation, easily fill vacancies, time to gain skills

Understand the significance of changes in the rates of employment and unemployment.

Higher migration may lower rate of employment, as may not get a job straight away.
Competition for jobs increases, improved skills

Understand the meaning of Balance of Payments deficits and surpluses on the current account.
BoP is a record of the financial transactions between one country and rest of the world over a period of one year.
Current account: trade in exports, imports and net investment income with the rest of the world.
1. Balance of trade in goods  value of goods exports – value of goods imported
2. Balance of trade in services  value of services exports – value of services imported
3. Net investment income  value of interest, profits and dividends earned from overseas accounts – value
of IPD paid to foreign holders of UK assets
4. Net current transfers  Transfers between governments e.g. aid
1 + 2 + 3 + 4 = current account balance
X>M increase in AD, injection
M>X decrease in AD, leakage

Understand the causes of an imbalance in the current account, at a basic level.

Reliance on imports/ exports
Value of the currency
Productivity
Demand for exports from a particular economy

Understand the costs of an imbalance in the current account, at a basic level.

Deficit = better SOL as can afford imports
Small deficit for a large economy has no economic significance (<5%)
Caused by poor competitiveness may lead to greater long term problems

Understand the advantages and limitations of HDI in making comparisons of living standards between countries.
Human Development Index published by UN and is a measure of economic development
1. Life expectancy – health
2. Averages years of schooling for 25 year old & expected years in education – education
3. GDP per capita converted to Purchasing Power Parity – indicator of SOL
Using components, index number between 0 and 1 generated
PPP – way of adjusting exchange rates to take into account different costs of living in different countries

Understand the advantages of HDI

Measures are reasonably easy to collect
Reliable
Education and health factors give broader measure

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Understand the limitations of HDI

Does not indicate distribution of income
Does not give full picture of QOL
Development is subjective to measure – more factors required

Interpret and use other measures of development.

 The percentage of adult male labour in agriculture
 Combined primary and secondary school enrolment figures
 Access to clean water
 Energy consumption per capita
 Access to mobile phones per thousand of the population.

Understand that national income can be shown as a circular flow.

Circular flow of income is a model of the economy showing the flow
of income between households and firms.

Analyse the impact of injections and withdrawals on the circular flow.

Injections - Additions to circular flow of income, increasing national income
- Investment - spending increases, and productive capacity in long term
- Exports - AD
- Government spending - AD AS (if supply side)
Leakages - Removal from circular flow of income, decreasing national income
- Taxes
- Spending on imports
- Saving
Injections > Leakages = expansion of national income
Injections < Leakages = contraction of national income
Depends on exchange and interest rates, government economic policy, consumer/business confidence UK/world

Understand the likely correlation between income and wealth.

Income is flow of money coming in, wealth is stock including assets
Normally, higher income = higher wealth

Understand the factors influencing the components of AD.

Consumption – highest contributing component (65%)
Investment
Government spending
(X – M) – (Exports – imports) – Balance of Payments, currently negative in UK

Understand the main influences on consumer spending

Interest rates – higher interest rates, more saving, therefore spending falls
Consumer confidence – high confidence, e.g. boom times means higher spending
Wealth effects – value of assets is high, more confident, more likely to spend
* Largest component
* Main driver of growth 1997 - 2007

Understand how changes in house prices may affect consumer spending.

As house prices rise, confidence grows (wealth effect) leading to higher spending

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Understand the main influences on investment
Interest rates - lower interest rates encourage investment as less likely to save
Confidence levels – more confidence, e.g. high growth, investors more likely to invest
Risk – risk-averse investors are less likely to invest
Influence of government and regulations – fewer regulations (red tape), easier to invest, increasing Investment
* Can fluctuate, depending on business fortunes
* Has a long term effect as well on AS

Understand the main influences on government spending

Deliberate manipulation of the economy through fiscal policy
Objectives of government in power – Labour spending more
* Creates long term benefits
* If spend too much, may have to raise taxes or borrow more
* Can only change annually, and must be approved by all MPs

Understand the impact on the current account of factors

Change in the exchange rate – if depreciation in currency, exports are cheaper overseas. A stronger currency
makes exports relatively uncompetitive and imports relatively cheap.
Increase in productivity, reducing business costs
Growth in consumer demand domestic/ abroad
Changes in the state of the world economy
High inflation domestically makes imports seem cheaper
* The change in the exchange rate might have opposite effects in the short and long run
* PED for exports and imports very low - stronger currency worsens the current account in the short run
* Negative in UK
* Open markets – important element of UK economy
Exchange rate is the price of one currency expressed in terms of another currency
Demanded/ supplied by:
Foreign residents, tourists
Foreign investors
Speculators
Value of £ Price of Price of Demand for Demand for X-M AD
exports imports exports imports
Appreciates      
Depreciates      
* Depends on PED of imports/ exports
* Short/ long run effects – opposite effects in short and long term
* Magnitude

Understand why AD slopes downwards. Show the relevant shifts in the AD curve when one of the components
change.
When prices are high, households can afford less, so overall demand in the economy will be low

Understand the factors influencing the amount that firms are willing to supply at various prices
Costs of production
Level of investment
Availability of factors of production
Low levels of GDP – spare capacity (horizontal section of curve)
- factors of production cheap
- small increase in price = large increase in output

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Explain factors that might cause a shift in AS
Changing costs of raw materials – increased costs means contraction
A change in the level of international trade or exchange rates
Technological advances – makes cost of production cheaper
Relative productivity changes
Education and skills changes
Regulation changes – more regulation increases costs

Understand the concept of equilibrium real national output

Point at which AS/AD meet
Apply to unemployment, inflation and economic growth

Explain the size of the multiplier, using the concept of the marginal propensity to consume; apply the multiplier to
shifts in AD
Multiplier occurs when an initial injection into the circular flow leads to a proportionately greater increase in AD
and GDP – positive multiplier effect
When a leakage from circular leads to a proportionately greater decrease in AD – negative multiplier effect
Marginal propensity to consume (MPC) – proportion of extra income that is spent
Multiplier = 1
1-MPC
More than one shift – second shift = second round etc
*Difficulty of measuring it
*Time lag – time it takes to come into full effect
*Size of leakages – e.g. more imports means reduced multiplier

Identify trends in growth rate; sustainable growth; understand output gaps in developed economies.
Economic growth occurs when a country produces more goods and services than it did in the previous year
Output gap – difference between actual and potential output
Positive – actual > potential
Negative – potential > output
The level of GDP still rises when an economy grows at a slower rate
Sustainable growth – economy grows without damaging future generations’ ability to grow

Explain the significance of factors such as investment or innovation; constraints may be in terms of absence of capital
markets or instability of government.
Changes in injections and leakages affect changes in the flow of income.
Impact of migration, changes in birth rates – more workers, but more benefits could be paid out higher population
increases AS in long term
Export-led growth – more sustainable

Understand the benefits of growth to citizens of increased standards of living, to firms and to government
Higher incomes for citizens – better SOL (but not necessarily)
Increased tax revenues or government
Increased profits for firms

Understand the adverse consequences of growth

Balance of Payment problems – increased imports
Income distribution – more inequality
Opportunity cost of growth – if high levels of investment, consumption sacrificed in short term/ environment
Externalities
Personal costs such as longer working hours
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Benefits or costs are greater
Difficulties of measurement
Changes over time

Identify, outline and evaluate the major current macroeconomic objectives

Increased economic growth
Control of inflation – 2% +/- 1%
A reduction in unemployment
Restoration of equilibrium in the balance of payments (X-M)
Making the distribution of income more equal
Protection of the environment

Consider basic conflicts between objectives, such as inflation and unemployment; or economic growth and
sustainability
Inflation and unemployment (Phillips curve)
If unemployment is low, inflation increases. If unemployment is high, inflation falls.
Money wages  when unemployment  as firms offer more money to attract workers
Wages are large cost for businesses, so changes in wages feed into changes in price level

Tarde-off between objectives

*Demonstrates that governments make choice between low unemployment and low inflation
*Proven wrong in stagflation of 70’s and low unemployment and inflation in 1997-2007 and
inflation/unemployment both rose in financial crisis

Growth and sustainability

More consumption/ more production harms environment
*Economists believe economic growth will lead to solutions

Inflation and equilibrium on the current account of the balance of payments

Inflation and economic growth – rise in AD increases price level
Raising interest rates to reduce inflation worsens income inequality as poor affected most

Impact of fiscal policy which might have inflationary effects in the short run but may be deflationary in the long
run
Level of government spending might affect the amount of money in the economy which may influence the
interest rate
Interest rate may influence the exchange rate and impact upon competitiveness

Evaluation in this section might include the difficulty in measuring the conflicts in the short and long term, or the
importance of the prioritisation of policies

Understand the practical application of monetary and fiscal policy

Fiscal policy is the use of taxes and government spending to manipulate the level of AD in economy
Public spending:
- Current, day to day spending
- Capital expenditure (investment)
- Transfer payments
- Debt interest
Government raises money through taxes
Direct taxes – income, NI
Corporation
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Capital taxes – inheritance, stamp duty
Indirect taxes – VAT, excise duty
Expansionary - G T injections increase, leakages fall
Contractionary - T G injections falls, leakages increase
Income tax – reduce tax bill – create injection of consumption – increase in AD – increase in GDP
Fiscal deficit – when G>T causes AD to rise
National debt – stockpile of fiscal deficit over the years
Effective
Impact on AD and behaviour
Reduce inequalities
Supply side effects in long run
Environmental goals
Ineffective
Decided yearly
Long time to have an effect – passed through parliament
Disincentive – e.g. rise in income tax
Crowd out private investment
Government failure
National debt has to be paid back

Monetary policy – use of interest rates and money supply to manipulate level of AD. Controlled by central bank
Interest rates – cost of borrowing and reward for saving
Role of Bank of England to set interest rates to manipulate AD to keep inflation around 2%. Also manage foreign
currency/ gold reserves and regulates UK financial system. Act as bankers to bankers.
Use data:
 Unemployment statistics
 Sales of UK exports
 Government spending plans
 Wage rate rises
 Consumer and business confidence surveys
 Costs of raw materials
 Asset prices
Tight monetary policy – increase in interest rates. More save, less spending
Loose monetary policy – reduction in interest rates
Based on forecasts of future inflation
(See separate sheet for Monetary Transmission policy)
MPC meets monthly
Effective
Respond quickly
Large impact on consumption and investment
Long run impact on investment and AS
Tough on inflation
Independent – no bias for election
Ineffective
Long time – time lags feed through to consumption
Magnitude of the interest change
May not have much effect on households with fixed rate mortgages
Distribution of income
Not accountable to electorate

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Identify measures that are used to increase the productivity of factors
Supply side policies – increase potential output of an economy by increasing productivity of factors of production
Education and training
Measures to increase incentives, such as changing the levels of benefits
Cutting the costs of bureaucracy in firms
Cur income tax rates
Reduce corporation tax
Privatisation
Tax credits for those in work
Effective
Increase productive potential
Remove bottlenecks in the economy
Raise competitiveness
Ineffective
*Problems in determining the magnitude of the effects of these policies
*Conflicts between policies
*Time lag
*High cost – opportunity cost
*Short term problems
*Increase in inequality

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