As Unit 2 Revision Part 1

8/10/2019 As Unit 2 Revision Part 1

1/21

INFLATION

KEYFACTS:

DEFINITION: A general rise in the price level in the economy

TARGET: Currently in England the inflation rate is 2.0%

HOW MEASURED:A number of goods (600) that are representative of the economy, ranging from

bread to petrol to lip-gloss, are put together into what is referred to as a "market basket or basket

of goods." The cost of this basket is then compared over time. This results in a price index, which is

the cost of the market basket today as a percentage of the cost of that identical basket in the

starting year. For example, the first year may be assigned the value 100, and then a 4% increase in

the next year would become 104. Also, a family expenditure survey is sent out each year to

determine which goods are most bought in the average household and helps inform the weightings.

The Office of National Statistics collects data from 120,000 retailers and measures increases

month on month.

NOT ALL PRODUCTS ARE EQUAL: Households generally spend more on things like petrol than

they do on things like postage stamps. Therefore, petrol is WEIGHTEDdifferently. An increase in

price of petrol will affect the overall inflation rate more than the same price increase in postage

stamps.

DIFFERENCE BETWEEN RPI and CPI: The RPI includes things related to housing such as the

interest on mortgages and council tax. These are not included in CPI. Therefore, the Government

sometimes prefer to use RPI as it looks better!

WHO SETS THE INFLATION TARGET: The Government decide the inflation target, but theMonetary Policy Committee at the Bank of England are in charge of making interest rate decisions to

try and keep to it! The aim is to stay within 1% +/- the actual target at all times.

WHAT CAUSES INFLATION?Two main things there is DEMAND PULLinflation this is when

the economy cannot supply enough products and services to keep up with demand, so prices are

forced upwards. There is also COST PUSH INFLATIONwhich is where supply shocks such as an

increase in price of oil increases the costs of many other products, leading to overall inflation.


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UNEMPLOYMENT AND GROWTH

WHY DOES IT MATTER?

SHOE LEATHER COSTS-the sheer cost of having to shop around for the best deal as

people no longer have a firm idea of what is a fair price. This also includes the cost of time spent

moving money into and out of bank accounts as the interest rate changes (to try and tackle inflation)

MENU COSTS- When prices change, businesses need to pay to print new menus, new

brochures, leaflets, price tags etc. This can get even more expensive when taking into account ticket

machines/vending machines etc

PSYCHOLOGICAL AND POLITICAL COSTS:People feel worse if prices go up, even

if their income has also increased. They can also impact poor/rich people in different ways and

disrupt the distribution of income and wealth

REDISTRIBUTIONAL COSTS:If people are on a fixed rate of pension, price increases mean their

pension is worth less than before. Similarly, if workers cannot negotiate pay increases, they will be

able to buy less with their salary than they did before. Also if interest rates change this affects

rich and poor in very different ways (savers/borrowers)If there is not a subsequent change in tax

rates in line with inflation, this can also lead to people being worse off than before.

UNEMPLOYMENT AND GROWTH:Inflation increases the cost of business

projects and means it can be hard for businesses to work out how much they can make. This

uncertain environment can lead to a decline in investment, which can dampen growth. This in turn can

lead to unemployment. If UK inflation is higher than other countries, our goods and services become

less competitive, and imports will become more attractive. This can impact the balance of goods and

services, leading to more withdrawals and less growth in the UK.

ASSESS QUESTIONS YOU COULD GET ASKED!!!!!!!!!!!!PROBLEMS WITH CPI AND RPI

RPI can be misleading if interest rates are low it can make inflation look less of a problem than it

actually is because this reduces mortgage payments (i.e. at the moment interest rates are low but

inflation is high!)

Some people do not complete the survey the weightings are based on, so the actual weightings may

not represent what the average household spends on each type of good

It has been reported that sometimes information used to calculate inflation is not calculated

regularly meaning they are inaccurate.
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3/21

ECONOMIC GROWTH (and GDP)

BOTH OF THESE GRAPHS ILLUSTRATE ECONOMIC GROWTH!

UNEMPLOYMENT

KEY FACTS:

DEFINITION: An increase in the productive capacity of an economy (the ability to produce goods and services)

HOW IT IS MEASURED:GDP or GNP are measured from one year to the next and any growth is expressed as a

percentage

IT CAN BE IN REAL OR NOMINAL TERMS: Real Economic Growth holds prices CONSTANT. This means that any growth is

real growth in productive capacity, and not just a result of inflation. Nominal growth makes no calculation for changes in

inflation. This means that the economy in question may not have grown at all, and the increase is purely inflation.

DIFFICULTY IN MEASURING: It can be difficult to identify whether there has been an increase in the actual capacityof

the economy i.e it is now capable of producing more than before, or whether there has just been an increase in utilising

resources. For example, using resources that are currently laying idle can lead to an increase in GDP from one year to

the next, but is not technical economic growth as the CAPACITY of the economy remains the same.

PROBLEMS:

Does not show us how income is distributed (are lots rich, but also many poor, or is it more equal?)

Only takes into account size of country if you calculate PER CAPITA (economic growth/population/Health)

Barter economies may be misrepresented as not recorded transactions

High growth does not always equal quality of life (pollution/too long working hours etc)

Developing countries may have more scope to grow than developed countries who have already technologically expanded. i.e

we are at different stages of development

The purchasing power of money can be different in different countries. So even if a country has a lower GDP than ours, you

may be able to buy more for your money in the other country, meaning their standard of living is not lower.(Thailand is a

good example of this)

SSESS QUESTIONS YOU MAY GET ASKED!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

ENEFITS: Widely recognised and understood so makes it easy to compare countries

ata is widely available

We do not have many other options available to us for measuring growth!
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4/21

UNEMPLOYMENT

KEY FACTS:

DEFINITION: Those who are currently without a job but who are seeking work at current wage rates.

HOW MEASURED: The International Labour Organisation (ILO) conducts a survey (post/phone) of the population aged 16-65.

To be classed as unemployed you need to have looked for work in the last 4 weeks and be ready to start in 2. The measure is

internationally recognised but is only a sample of the country. In the UK they also use the CLAIMANT COUNT which is the

number of people that are claiming benefits such as job seekers allowance. It looks at people aged between 18 and 65. The

UK main measure is the ILO survey.

ASSESS QUESTIONS YOU MAY BE ASKED!

COSTS OF UNEMPLOYMENT

COSTS TO THE UNEMPLOYED PERSON AND DEPENDANTSObviously there is a cost of loss of income. However, there

are many costspeople may suffer with stress, a breakdown, marriage breakdown, illness and mental issues as a result

of being unemployed. They may feel worthless and a failure. Also the longer they are out of work, the less likely they are

to have a job as they lose their skills and potential employers are put off by their lack of recent work experience

COSTS TO LOCAL COMMUNITIESIf there is high unemployment, the area may become run down. Unemployed may

turn to drugs, crime and violence. Shops may have to close down if the high unemployment means they do not have

enough sales to stay open.

COSTS TO TAX PAYERSUnemployed are no longer paying taxes and are now costing the government through benefits

COSTS TO THE ECONOMY AS A WHOLELoss of output now people are not working, and social costs associated with

increased crime/depression etc

ASSESS QUESTIONS YOU MAY BE ASKED!

Why does unemployment persist even as an economy recovers?

Unemployment is a LAGGINGfactori.e it happens after an economy has started

performing badly

Contracts and negotiations may mean there is a time delay between a drop in sales

for a business and the laying off of staff

Making people redundant is costly and causes bad publicity, and recruiting and

training new people if the economy recovers is expensive, so many businesses hold

out as long as possible to see if the situation improves

People may not believe the recession is over and therefore continue not to

consume, meaning sales fall further and firms have to make cuts


5/21

ASSESS QUESTIONS YOU MAY BE ASKED!!!!!!!!!!!!!!!!!!!!!!!!!!!!

PROBLEMS WITH CLAIMANT COUNT:

Xit does not take into account people who are looking for work, but are not entitled to claim benefits, for

example because they are too wealthy

Xit takes into account people who ARE working but are claiming benefits illegally

BOTH measures may underestimate unemployment because they dont look at people who are in part time

work but want full time work, those training when they would prefer to be working or those that are not

actively seeking work, but if offered a job would take them.

On the other hand, it includes people that have no qualifications, or may have physical or mental disabilities

that some would argue makes them unemployable and therefore they should not be included as unemployed.

ASSESS QUESTIONS YOU MAY GET ASKED!!!!!!!!!!!!!

MIGRATION CAN HAVE A DAMAGING AFFECT ON EMPLOYMENTThe UK is seen as a favourable place to

live. In addition, it is quite easy to move here as many countries used to be part of the common wealth, or

are in the EU so can move here without restriction. This means that many people are attracted to the

country and, especially the benefits we give. These people may register as unemployed and have no real

intention of getting a job.

MIGRATED WORKERS MAY NOT HAVE THE RIGHT SKILLSLanguage barriers, differences in qualifications or

lack of skills/experience may make it difficult for migrants to find a job and therefore they add to the

unemployment of the country.

MIGRATION CAN HAVE A POSITIVE IMPACT The UK is an attractive place to live and is seen to have lots of

opportunitiestherefore entrepreneurs and business people may migrate. They are likely to invest money

and consume a lot of goods and services which should generate jobs and reduce unemployment in a number

of ways.

Migration increases the supply of labour. This can decrease the wage rate which may mean businesses are

willing to hire more people, leading to a rise in employment

Migrants may be able to fill jobs that we cannot fill with domestic people because they either do not have

the right skills or do not want to job. Therefore employment levels will go up.

Increased population means increased consumption which may create even more jobs

TYPES: FRICTIONAL (between jobs), CYCLICAL (boom/bust) , SEASONAL

(summer/winter), STRUCTURAL (mining), GEOGRAPHICAL (less jobs up

north)
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6/21

Balance of Payments

WHAT CAUSES CURRENT ACCOUNT DEFICITS AND WHY ARE THEY

BAD?

High inflation makes domestic goods expensive, so consumers may choose

to buy abroad. But this can lead to flows of money out of the country,

meaning a fall in AD In the long run, if everyone is changing up their pounds to foreign

currency, the supply of pounds increases, meaning the value drops. When

this happens, it is cheaper for other countries to buy from us and

cheaper for tourists to visit, so in the long run this may improve the

balance of payments

Some countries do not have the capacity to supply AD and have to resort

to importing, or may be unable to produce many goods and services

KEY FACTS:

DEFINITION: a record of all the financial dealings over a period of time between economic agents of one

country and all other countries. It comprises of the CURRENT ACCOUNT(purchases of goods and services)

and the CAPITAL ACCOUNT( money related to saving/investment etc)

A CURRENT ACCOUNT DEFICITrefers to when exports are smaller than imports. i.e more money is flowing

out of the economy (withdrawal) than in (injection) This is not always a problem, if the deficit is only small

or short term.

LONG TERM CURRENT ACCOUNT DEFICITS Can be bad as it means we own money to other countries.

They may decide that they do not think we are going to pay them back and refuse to sell to us until we pay

it back. This leads to less goods being available in the country. This can be further the case if the we start

exporting to try and reduce the deficit, meaning less goods available in our domestic economy.

LONG TERM CURRENT ACCOUNT SURPLUSESCan be good because it stores up wealth for times when the

economy may need funds in the future.(Japan did this to fund pensions as the population ages) However,

these resources could be used elsewhere, such as for investment. Also it can cause friction with other

countries as they may feel they cannot develop their own businesses because they are reliant on exports

THIS IS NOT THE GOVERNMENT DEFICIT!!!!!!!!!!!!!!!!!!!!!!!!!!!!!


7/21

THE HUMAN DEVELOPMENT INDEX

OTHER MEASURES OF DEVELOPMENT

PERCENTAGE OF ADULT MALES IN LABOUR IN AGRICULTURE (shows how developed the

country is in terms of tertiary sector)

ACCESS TO CLEAN WATER

ACCESS TO MOBILE PHONES

ACCESS TO SANITATION

PAVED ROADS

KEY FACTS:

DEFINITION: The Human Development Index (HDI) is a composite statistic used to rank countries by level of "human

development it takes into account the life expectancy rate, literacy rate, school enrollment and GDP per capita in acountry (ppp). It is between 0 and 1 and countries are ranked.

COUNTRIES WITH LOW HDI: Ethiopia, Congo,

COUNTRIES WITH HIGH HDI: UK, Germany, USA

ASSESS QUESTIONS YOU MAY GET ASKED!

ADVANTAGES OF HDI

QUICK AND EASY TO COLLECT EASY TO COMPARE COUNTRIES

LOOKS NOT ONLY AT GDP, BUT HOW IT IS BEING USED (I.E HEALTH CARE AND EDUCATION)

GIVES A LONGER TERM VIEW (I.E LIFE EXPECTANCY AND EDUCATION CAN INDICATE WHETHER GROWTH IS

SUSTAINABLE/HUMAN CAPITAL IS IMPROVING)

DISADVANTAGES OF HDI

NO ACCOUNT OF HOW INCOME IS DISTRIBUTED

IGNORES OTHER FACTORS LIKE WAR AND POLITICAL PROBLEMS

JUST BECAUSE LIFE EXPECTANCY IS HIGH DOES NOT ALWAYS MEAN QUALITY OF LIFE IS HIGH

SCHOOL ENROLLMENT IS ONLY EFFECTIVE IF EDUCATION IS OF A HIGH QUALITY DOES NOT REPRESENT LEVEL OF EQUALITY IN A COUNTRY
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8/21


9/21


10/21

Formula: Withdrawal = Net Savings + Net Taxes + Imports

INVESTMENTCAN INCREASE PRODUCTION AND CONSUMPTION (MORE

JOBS&INCOME)

EXPORTSCAN IMPROVE BALANCE OF PAYMENTS AND INCREASE CONSUMPTION

AND INVESTMENT AS MORE MONEY IN ECONOMY

SAVINGS/IMPORTS/TAX REDUCE DOMESTIC CONSUMPTION


11/21

AGGREGATE DEMAND

REMEMBER TO ALWAYS LABEL YOUR AXIS!!!!!!

National output=National expenditure=National Income

AS PRICE LEVEL INCREASES, DEMAND FALLS BECAUSE:

CONSUMPTION FALLS: People will not be able to afford to buy as much and will have to borrow

money. This extra demand will increase interest rates, making borrowing expensive. As a result,

people will have to consume less

Also, the WEALTH EFFECT will mean peoples assets now make them feel less wealthy as

everything is now more expensive. Feeling less rich makes people spend less!

INVESTMENT FALLS: As interest rates rise (due to increased demand for borrowing) investments

become more expensive and less attractive to businesses. The risk is greater.

DEFINITION: Total of all demands/expenditures in the economy at any given price.

COMPRISES OF: Consumption (spending by households on goods and services)

Investment(Spending by firms on investment goods)

Government Spending (on current spending such as wages and investment such as roads)

Exports minus imports(foreigners spend money on domestic goods, so this money is part of our

National expenditure but consumption on inputs does not contribute to our national income or

Relate to national output)

THEREFORE: AD=C+I+G+(X-M)

IMPORTANT FACT: CONSUMPTION MAKES UP 65% of AGGREGATE DEMAND!


12/21


13/21

An increase in businesses profitabilitywill give firms more money to use for investment

GOVERNMENT SPENDING MAY RISE AT ANY PRICE BECAUSE:

Government policy has changed (maybe because a new party have come into power. For example,

when Margaret Thatcher was prime minister government spending was cut dramatically, but has

since increased.

EXPORTS AND IMPORTS MAY CHANGE AT ANY PRICE BECAUSE:

Quality of domestic goods has increasedmaking them more attractive to both foreigners and

domestic customers

The exchange rate has fallenmeaning our exports are more competitive and imports are more

expensive

ASSESSMENT QUESTIONS YOU MAY BE ASKED!!!!

A strong exchange rate may not impact exportsdepends on price elasticity of demand

Interest rates may not impact investment if confidence is low (look at the moment!)

Investment does not just depend on the interest rate, it also depends on availability of

credit (are banks lending money freely)

If people do not think tax breaks are permanent, or expect them to be followed by a further

increase in tax, they may not consume more (they may save the money)

The multiplier effect may mean that changes to some components of Aggregate demand

affect overall rate more than others

The impact of any exchange rate change is also dependent on what is happening in the

world economy.


14/21

CONSUMPTION IN DETAIL

DEFINITION: Spending on consumer goods and services over a period of time. These

include DURABLE (i.e cars) and NON-DURABLE (i.e food).

KEY FACTS: Consumption is linked to a persons DISPOSABLE INCOME, which

includes salaries and benefits. It is also dependent on how much people choose

to SAVE from their income. How much individuals save and how much they spend

is referred to as the MARGINAL PROPENSITY TO CONSUME:

%change consumption

% change in income

FACTORS WHICH EFFECT CONSUMPTION:

WEALTHif house prices of stocks and shares values go up, people feel

they are richer and so will spend accordingly.

INFLATIONInflation reduces the value of money a household has.

They therefore may decide to save their money rather than spend it. On

the other hand, inflation may actually encourage people to spend more,

buying goods before prices increase any further.

INTEREST RATE-An increase in the interest rate leads to more money

having to be spent on mortgage and loan repayments, leaving less for

buying goods. Also, if interest rates are high, this may put off consumers

borrowing money to buy things

AVAILABILITY OF CREDIT are banks lending (i.e they are not at the

moment, so it is irrelevant if interest rates are low!)

EXPECTATIONS if people think the economy is booming, they willspend, expecting future increases in wages. The reverse is true in a

recession

THE AGE RANGE IN THE COUNTRY young borrow, middle aged save

and old people spend their savings! (on average)


15/21

THEORIES OF CONSUMPTION

NAME: CONSUMPTION FUNCTION

BY: JOHN KEYNES

THEORY:Income is most important factor in determining short term consumption.

People do not change patterns significantly due to interest rate or wealth changes.

As people get higher incomes, they will spend less and less of it. So the rich getting

richer does not add to consumption. Therefore he thought the economy would stagnate

WRONG OR RIGHT:There is little evidence to prove this theory right!

NAME: THE LIFE CYCLE HYPOTHESIS

BY: FRANCO MODIGLIANI

THEORY:Consumption is not to do with current income. Households form an opinion

about their likely income over their lifetime and base current spending on that. This is

like you borrowing money to go to uni, because you believe you will get a job with a high

enough wage to pay it back. As you get older, you will save for your retirement, then

when you stop working, spend your savings.

WRONG OR RIGHT: There is substantial evidence which supports this theory

THEORY: THE PERMANANT INCOME HYPOTHESIS

BY: MILTON FRIEDMAN


16/21

THEORY: Develops on Modiglianis idea. He said consumption was based on

PERMANANTincome. This is affected by wealth, interest rates and income increases.

He said that people spend all of their income over their lifetime. He argued that

current income does affect consumption, unlike Keynes. However, he said how it affects

consumption depends on whether it is deemed permanent or not. I.e a lottery win willleave to saving and spreading out consumption over the persons lifetime. In contrast, a

income rise will lead to a larger increase in current consumption, as this income will be a

permanent increase.


17/21

INVESTMENT

DEFINITON: addition to the capital stock of the economy, such as factories,

machines, offices and stock. IN ECONOMICS INVESTMENT AND SAVING

ARE NOT THE SAME THING!!!!!!!!!!!!!!

Net investment is very importantbecause this shows how much has been

added, once replacing worn out capital has been taken into account. For

example, replacing a broken computer does not add to the capital stock, it

just maintains it.

Investment can be physical(machines, buildings) and human(training,

education)

WHAT EFFECTS INVESTMENT?Cost of capital goodsthe higher the price, the lower the amount of

investment

Technological changeif technological change makes capital more

productive, investment will lead to greater returns than before. This will

provide an incentive for firms to invest, so they will invest more than

before.

Expectations whether firms are optimistic or dubious about the future

will effect whether they think investments are viable options.Government policy The government can set rules and regulations that

makes investment easier or more attractive.

Profits does the firm have money to invest?

Availability of investment projects is there favourable projects

available for investment?


18/21

ECONOMIC GROWTH CONTINUED

DEFINITION:The change in the productive capacity of an economy.

HOW DO WE MEASURE IT?It is impossible to produce a figure for

the value of machinery, workers etc. Therefore GDP changes are

measured to give an indication.

THE OUTPUT GAP:

GDP may not actually be a good indication of an economies capacity. In

times of recession, the economy is likely to be working below their

potential (NEGATIVE OUTPUT GAP), on the other hand, in times of

growth, the economy may be working above its true capacity (payingworkers overtime, opening factories for longer hours) this is not

sustainable and therefore is not a true reflection of the economies

capacity.

In the graph above the blue line shows the productive potential of the

economy over time, whereas the red line shows where actual GDPis at

various points. The difference between these lines is the OUTPUT GAP.


19/21

CAUSES OF ECONOMIC GROWTH

LAND finding oil resources/reclaiming land from the sea

LABOUR-Increase in number of young people joining the

labour force

Increase in amount of women joining the labour force

ImmigrationEducation of workers

Flexibility (which is linked to education ie being able to do more than one

job)

CAPITAL Investment leads to economic growth.However, not in all cases. Housing is an investment, but it does not lead to

increase in output in the future. Also, some investment does not work out,

leading to a poor rate of return.

TECHNOLOGICAL PROGRESSAs technology improves,

the average cost of production will fall. This increases efficiency and the

amount businesses can produce. Also, new products coming to market

encourage consumption, as consumers want to buy new products. Without

this, there may be no new spending, and no economic growth (as no money

available for investment)


20/21

WHY IS THE UKS GROWTH RATE A LITTLE BIT RUBBISH

CATCHING UP It can be argued that it is obvious that countries like

China are going to have higher growth rates than the UK, because we have

already grown and developed so much. The UK has already moved from

agriculture, to manufacturing, to tertiary sectors, so a lot of our

potential for growth has already been realised

EDUCATION AND TRAININGIt has been suggested that the UK

focuses too much on the more able students and neglects the lower

ability students. This can mean these students become unemployed and

are not contributing to the countries output.

FLEXIBLE LABOUR MARKERSthe EU, and the UK particularly are seen

to have many rules and regulations. This makes it harder for firms to hire

and fire people and as a result efficiency can be affected.

TAXES The UK has high levels of taxes. Corporation tax puts people

off starting businesses or aiming to achieve really high profits. National

insurance makes hiring workers expensive and can discourage firms taking

on new workers. All of this reduces the amount of investment and

enterprise in the country, which also means missed growth opportunities

SHORT TERMISMshareholders want quick returns, they are not

interested in where the firm will be in ten years. Therefore, firms may

focus too much on the short term, for fear of upsetting their investors if

they do not see returns quickly. Similarly, banks will only lend for a few

years, which can hinder long term investment plans of businesses.


21/21

WHY IS GROWTH SOMETIMES BAD?

Negative externalities migrants leaving their families in search of

jobs, often living in poor conditions/may not be happier even if income has

increased EV: BUT WERE THE GOOD OLD DAYS REALLY THAT

GOOD AFTER ALL, LIFE EXPECTANCY HAS INCREASESUGGESTED BETTER STANDARDS NOW

Growth is not sustainable resources will run out/pollution will get out

of control/greenhouse gases will increase EV:BUT THE GOVERNMENT

ARE ADDRESSING THIS WITH HYBRID CARS AND GREEN

SOURCES OF ENERGY

EV: IT IS ALL VERY WELL FOR THE RELATIVELY RICH PEOPLE OFTHE SOUTH TO CLAIM GROWTH IS BAD, BUT IF GROWTH

STOPPED FOREVER, WHAT WOULD BECOME OF THE DEVELOPING

COUNTRIES WHO STILL SUFFER FROM POVERTY IF NO FURTHER

GROWTH OCCURED?

Documents

As Unit 2 Revision Part 1