Macro 2
Analyse, using a diagram, what is meant by the output gap. (6 marks)
*Draw a diagram, I'd personally draw a PPF marking points X, Y and Z. I would place X within, the curve, Y on the curve and Z outside* The output gap is simply the difference between actual, present output and the potential output in an economy. An output gap can come in two main forms. Firstly, point X on the diagram shows a negative output gap. This is because you are producing within the PPF and therefore have the potential to increase output. Point Y, on the other hand, lies on the curve itself and there is thus no output gap. However, point Z shows a rare position where there is actually a positive output gap. This means that the economy is actually producing beyond its potential and therefore lies beyond the curve, as shown in the diagram. Such a position can occur when employers in the economy work a lot of overtime. This would mean they would increase their productivity and output to beyond what was previously expected, creating a positive output gap.
Analyse the consequences of a continued rise in long term unemployment in the UK (36% of unemployed) (6 marks)
A continued rise in unemployment may cause hysteresis meaning unemployment causing unemployment. Workers that are looking for a job may keep getting rejected and as this happens because labour is derived demand there is not a need for extra employment because in the long run as unemployment drops there will be less of an incentive to increase production. This could be very deadly on the economy as it may lead to structural unemployment where workers lose skills and rely on benefits. This would cause a deterioration in government finances because there would be higher spending on benefits this would result in a lower tax revenue collection. This suggests there would be a huge opportunity cost on behalf of the government as there would be cuts in spending in crucial public sector finances like healthcare and education. This shows there would be a slowdown on future growth. Furthermore these cuts could harm those who are desperate on the health care for example this may lead to social costs like depression, crime and rioting.
Describe two features of a single market (4)
A single market removes restrictions on the free movement of labour and capital between countries. This ensures that resources are allocated to where they can be best used increasing trade. Another feature is that it removes non-trade barriers through agreeing a common approach to product standards, employment laws, taxation policies, competition policies and state aid to industry. This deepens economic integration as firms within the single market will not have barriers that withhold them from trading as trade will have become more simple and easier therefore saving costs and increasing trade.
Analyse the reasons why a re-balancing of the economy is considered essential. (6 marks)
An economy can be rebalanced by shifting away from consumption and government spending towards investment and exports. An increase in the component of AD may occur due to the government developing policies to increase investment. For example, the government may reduce corporation tax or encourage businesses to invest by increasing the tax allowance on investment. This would encourage domestic firms to increase investment into their business. Investment is a component of aggregate demand, and a rise in this component would raise real GDP, and cause a fall in unemployment. In addition, a rise in investment may be due to foreign direct investment, which may also increase LRAS, causing an increase in the economy's factors of production. A rise in LRAS would also cause a fall in the price level. This means that the price of goods and services would not rise as quickly. As an economy increases investment, domestic firms become more productively efficient. This means that they can produce goods at low unit costs. As a result, firms become more internationally competitive. This is because, an economy can produce at similar costs to other countries who have low unit labour costs in particular. This means that prices charged for homogenous products will be similar, providing consumers with more choice, and potentially increasing demand for an economy's exports. This would cause a rise in net exports, and improve a country's trade deficit.
What is the Claimant Count? What are the advantages and disadvantages?
Claimant count This is the number of people claiming the job seekers allowance (JSA). The figures are published monthly. Advantages Cheap to collect Available every month It's a complete count and not a survey Disadvantages It's based on administrative rules - therefore it excludes certain groups, e.g. anyone under 18, men over 60, full-time students, the long-term sick and those claiming Incapacity Benefit (IB) Provides limited analysis of the characteristics of the unemployed The Stigma of claiming benefits
assess the effects of China's demand for commodities on Brazil's economy. Illustrate your answer with an aggregate demand and aggregate supply diagram
Commodities defined - evidence refers to both minerals and agricultural products Increasing demand for commodities causes right (outward) shift in AD Increasing average price level and real output Movement along SRAS Bring about increasing investment in mining industries and agriculture Increased employment in mining/agricultural industries Multiplier effect In long term may lead to increase in LRAS EVALUATION Higher inflation • Increase in currency value and negative impact upon manufacturing exports and increased imports • Lack of competitiveness of other Brazilian sectors • Growth is not balanced • Environmental degradation/impact • Risks associated with reliance upon a small range of commodities for exports
assess the likely effect of a fall in the sterling exchange rate on the UK's deficit in the trade of goods and services.
Definition of a fall in the exchange rate OR the exchange rate (2) • Fall in the price of exports leading to a rise in exports • Rise in price of imports leading to a reduction in imports • Leading to a reduction in the trade deficit EVALUATION • 25% depreciation in exchange rate, so effects likely to be significant • Extract states that import volumes rose, rather than fell as would be expected • Large price differential persists even after depreciation • Imports and exports may not be that price sensitive (focus on quality) and so the deficit may not reduce so quickly • Depreciation may lead to inflation which may in the long run eliminate the trade benefits of a fall in the sterling exchange rate • Extent of industrial production reduction • Producers may not pass on depreciation in their final prices • Extent of dependency on overseas countries • Depends on economic conditions in UK's main export markets (questioning ceteris paribus)
Explain how a change in interest rates might affect the level of investment
Definition of investment is an increase in the capital stock or the buying of capital goods • Fall in interest rates reduces the cost of borrowing and so makes investment cheaper leading to more investment Rise in interest rates increases the cost of borrowing and so makes investment more expensive leading to less investment • Fall in interest rates leads to rise in consumption and therefore investment OR REVERSE(4 marks) • Rise in interest rates leads to the incentive for firms to save and therefore a fall in investment OR REVERSE • Reward other influences e.g. confidence, access to finance
explain two factors that could influence the level of household saving.
Degree of job security/ confidence • changes in house prices and/or share prices • interest rates paid by banks • savings schemes e.g ISAs; index-linked savings certificates • changes in incomes • credit should also be given for convincing points made about an ageing population requiring increased savings in the longer term as a result of the level of welfare benefit provided.
Assess the likely impact of a cut in interest rates on the distribution of income
Distribution of income improves (if justified): identification of groups (ie winners and losers) affected by cut in interest rates, for example savers, borrowers, mortgage holders, pensioners, hire purchasers. • higher-income groups are not necessarily higher savers • higher-income groups might have larger mortgage interest payments as a proportion of their income • time implications for impact of interest rate changes • effects on income might take longer than wealth effects
Explain factors which may have risen unemployment
Fall in UK domestic demand in the recession causing more unemployment generally • Decline in real incomes • Global recession resulting in falling exports • UK reliance on service sector which has a low propensity to export • Loss of UK competitiveness e.g. linked to a higher rate of inflation • The minimum wage being too high • Net immigration rates Exchange rate changes • Structural unemployment • Reduction in availability of credit • Tightening of fiscal policy EVALUATION • Timing of the factors and their expected persistence • Regional/sectoral/occupational differences • Inequality or equity issues
Assess the falling impact of real incomes on the price level and equilibrium output
First point: Falling real incomes lead to falling consumption, with lower consumption firms will reduce investment. Leads to AD to shift to the left, fall in price level and in real output Second point: EVALUATION • Elasticity of AD and AS • Timing - Short Run- Long Run • Regional/sectoral/occupational differences • Inequality or equity issues • Magnitude of the fall
What relationship might be expected between average earnings growth and the unemployment rate?
Inverse or negative relationship or trade off or if one is high the other is low when nearing full employment or capacity the economy begins to overheat and prices rise (or cost push inflation from wage-price spiral) • Keynesian AS curve is upward sloping • use of an AD/AS diagram or Phillips curve (up to 2 marks for diagrams) • Phillips Curve explained • reverse analysis i.e. if unemployment is rising, then workers have less bargaining power and earnings growth will be slower • incentive effect EVALUATION If no relationship explain that the Phillips curve is unrealistic • Any plausible analysis
Comment on whether rebalancing the economy away from consumption and towards investment will make economic growth more sustainable. (10 marks)
Firstly if we are encouraging firms to invest, aggregate demand increases, causing a rise in real GDP. This improves productive capacity as firms may invest in capital equipment and therefore become more efficient. This causes AS to shift to the right. This makes economic growth more sustainable as inflation will be combated in the long run as the price level does not change meaning we can still maintain our international competitiveness. On the other hand, it is dependant on how much AS does increase. If AS only increases by a small amount we will still experience inflation and a rise in the price level. This could make our prices not attractive as our export prices will rise losing international competitiveness. Therefore economic growth would not be sustainable in the long run as our international competitiveness would erode. Despite this, cutting corporation tax will mean businesses retain more profit. This means they could reinvest that money back into their businesses and may even attract foreign investment. This again will increase AS as productive capacity increases as real GDP increases. However, businesses may not invest and instead retain profits. This may be used to satisfy shareholders and therefore would not benefit the economy. Finally, another way the government have tried to rebalance the economy is by increasing access to finance for businesses. This makes it cheaper and easier for them to borrow. This will encourage investment in the economy increasing productive capacity. However, this may not be sustainable in the long run as the rate may not be cheap enough as firms are still having to pay interest on top of the loan. Therefore investment may not even occur. Furthermore, business confidence may still be low and businesses may not be willing to invest.
Analyse possible reasons for the continuing rise in the national debt at a time of fiscal austerity. (6 marks)
Fiscal austerity is where the government tries to fix the budget deficit through cutting government spending and increasing tax revenue. It usually occurs in the form of 80% government spending cuts and 20% increase in taxes. When a government is using austerity and the budget deficit is not reducing it usually occurs due to a fall in the real value of people's wages. As people have been earning less and less money over the last few years they have been paying less tax revenue. This therefore means that the deficit is not reducing and means the national debt is not reducing either.
Comment on the extent to which growth in UK exports and FDI may help to rebalance the UK economy? (10 marks)
For the UK to rebalance the economy, the UK must decrease their foreign consumption (imports) and reduce government spending and move towards exporting UK goods and services and increase business investment (FDI) Firstly through a growth in exports our balance of payments improve. Our trade deficit will reduce and soon become a trade surplus. Aggregate Demand also increases, since a rise in exports will also increase net exports. This is a component of aggregate demand, which causes AD to shift to the right. This increases real GDP, and results in a fall in unemployment. Furthermore an increase in FDI will help businesses to create more jobs, reducing unemployment and thus can reduce spending on benefits - reducing government spending, and further rebalancing. As well as this, an increase in exports may boost business confidence increasing business investment which also leads to a fall in unemployment and government spending due to job creation from investment. This creates a multiplier effect as spending increases (more jobs) which can then cause more business and foreign investment into the UK thus rebalancing away from government spending. This overall increases AD and AS, which means there is a rise in the productive capacity. Despite this, it is dependent on other components of AD. Imports may grow at a faster rate than exports, which means we would not be rebalancing but moving away. Furthermore consumption may increase as a result of job creation from FDI as people have more disposable income and thus people may import more and spend abroad leading to higher leakes and thus a reduction in the multiplier. This therefore is not creating as much confidence in our economy as we could and thus reducing future foreign direct investment. As well as this FDI can be a leakage, if foreign firms decide to repatriate profits back into their own country meaning we do not see any improvements in our economy resulting in no change in employment back home. Finally these changes take time to implement and may only be short lived and thus may not rebalance unless it continues in the long term.
Explain the concept of hysteresis (4 marks)
Hysteresis is when unemployment causes unemployment. Forms of unemployment such as structural unemployment can cause workers to lose skills over time. Particularly in an economy such as the UK, who are specialised in the provision of high quality services by a highly skilled labour force, losing skills can reduce chances of being employed once again. This is because firms seek to prevent costs of training, so they search for workers who have experience in the sector. As a result, workers who have suffered from hysteresis remain unemployed, resulting in a rise in long term unemployment.
Assess the likely impact of the UK's relatively poor productivity performance on its economy.
Impact on current account balance: UK goods and services will be less competitive. Therefore, exports will become relatively more expensive and imports are relatively less expensive • Increase in unemployment • Lowering of output • Reduction in investment • Increase in inflation • Exchange rate will weaken • Lower profits for firms leading to lower investment EVALUATION • Depends on the price elasticity of demand for X and M • Other factors may be more important in determining the current account e.g. exchange rate, quality of goods and services • Problems with measuring productivity • Changes will take some time to come into effect • Impact of other factors • Magnitude
What is the ILO What are the advantages and disadvantages?
International Labour Organisation (ILO) Survey The ILO survey takes its figures from a wider survey of employment called the Labour Force Survey (LFS). The LFS is carried out on a quarterly basis and is done by a telephone survey involving 60,000 adults. The survey collects details on household size and composition, age, sex, marital status, ethnic origin and occupation of residents. Advantages It's the internationally recognised way of calculating unemployment - therefore the UK's unemployment rate can be directly compared with other EU countries. Provides more detailed characteristics of the unemployed, e.g. occupation, age, gender. Disadvantages More costly to collect Figures are only available every quarter Prone to sampling and response errors
Analyse the effects of international trade [6]
International trade has many different effects on the economy. One effect is on the global GDP. As countries become more engaged they become more productively efficient and as a result they use less scarce resources. This causes the PPC curve to shift out to the right as it is possible to increase the number of goods and services produced with the same amount of resources. This is possible as countries can specialise due to international trade, as global production increases so does the global GDP. Another effect of international trade is that firms are able to experience economies of scale. Without international trade the production of goods and services would be limited to the domestic market. By opening up to global markets, firms are able to experience higher economies of scale. The increase in production levels will lead to a reduction in the average cost of production. However infant industries, relatively new industries, may lack the economies of scale to compete in a global market, therefore tariffs and quotas need to be used to protect them. International trade also increases the level of competition for domestic firms. Competition from global firms puts downward pressure on domestic prices, this reduces the domestic firm's profit margins. This increases production efficiency as firms will be looking to reduce costs to increase profit. (incomplete will finish it soon)
Evaluate the use of supply side policies to increase the rate of economic growth in Canada or the UK
Interventionist policies including: • Education and training to raise levels of human capital/make labour more flexible to cope with changing structure of economy • Research and development (R&D) to develop new technologies or production techniques improve efficiencies • Improved infrastructure to allow for better transportation linkages in the economy; better telecommunications linkages in the economy; Infrastructure is what enables economic activity to take place Market-oriented policies including: • Reduction in direct taxes (income tax) • Reduction in direct taxes on firms (corporation tax) • Labour market reform may be including reduction in trade union power/reduction in minimum wages/reduction in unemployment benefits • Deregulation • Privatisation and competition policy EVALUATION Interventionist supply-side policies are costly so there is an opportunity cost for the government • May only be effective over the longer term. • Tax incentives - may be less income for governments - unless the Laffer curve hypothesis is to be believed • A lower level of trade union power is likely to result in less job security and worsening conditions for workers • May be a reduction in living standards for workers on the minimum wage and for the unemployed • Deregulation negative effects on labour or the environment • Some firms are nationalised so that they can provide an essential service, e.g. water, electricity or railways, at lower prices/sectors where there might not be sufficient demand for private firms to operate.
assess the likely economic impact of falling business investment in the UK. Illustrate your answer with an aggregate demand and aggregate supply diagram.
Investment is included in GDP measure • C + I + G + (x-m) • Investment is important component of AD and LRAS and productive potential, thus falling investment reduces AD in the short term • In the long term lower investment may reduce output potential of economy reducing LRAS • Relate to GDP growth - Multiplier effect upon AD • Relate to total GDP change in UK and Canada • Examples of capital investment such as new factories, other buildings, machinery and vehicles • May also be investment in infrastructure (EG roads, airports) or human capital (EG training and education) • Lack of investment may result in higher unemployment and therefore government spending • Relate to falling productivity Evaluation As AD increases (perhaps due to increasing demand for exports) then investment may grow again (a lagging indicator) • Low investment may be result of falling demand in export markets (due to low economic growth in USA or EU) may be short-tem • Impact upon GDP depends upon size of multiplier • References to policies likely to increase investment - EG tax incentives, monetary policy • Data may be inaccurate/difficult to collect therefore misleading • Falling AD and growth, rising unemployment may reduce tax receipts an increase fiscal deficit
What are the limitations of GDP to compare living standards over time?
Limitations of GDP as an indicator of comparative living standards over time Inflation - to make a proper comparison over time we need to adjust for inflation. It's better to compare real GDP not nominal GDP. Population growth - to make a proper comparison we need to look at GDP per head not just total GDP. Quality of goods and services - GDP may grow over time but it doesn't tell us anything about how the quality of goods and services may have changed. Externalities - GDP may grow over time but it doesn't tell us anything about how external costs may have changed e.g. pollution, congestion. Regional differences - GDP is an average with regional differences.
Explain two possible problems for the UK economy of 35% of the unemployed being "out of work for more than 12 months"
Loss of income and/or credit problems (such as house repossession) will have a downward pressure on consumption and AD, and therefore on output. It will have an upward pressure on unemployment. • Loss of skills and other human capital: hard to get into or back into labour market and increased welfare problems for individuals and dependents and poverty issues, possibly leading to a reduction in the PPF and a downward pressure on actual and potential growth. • Government revenue falls so spending likely to fall, leading to a downward pressure on AD and therefore on output. It will have an upward pressure on unemployment. • Increased government expenditure e.g. on benefits • Social costs: large numbers of idle workers can have a negative effect on society, for example crime, morale, social disintegration, possibly leading to a reduction in the PPF a downward pressure on actual and potential growth. • Opportunity costs: resources could be used elsewhere more effectively, leading to an actual output inside the PPF a downward pressure on actual growth • Downward pressure on wages caused by surplus of workers: could lead to increased inequality.
Explain two likely costs to the UK economy of a sustained deficit in the trade of goods and services on the current account of the balance of payments.
Low/constrained aggregate demand leading to suppressed economic growth • Net withdrawal from the circular flow of income leading to falling output • As labour is a derived demand creation of unemployment in export and/or import substitute industries • Rising unemployment means lower average incomes and a consequence of that such as lower domestic consumption or higher total paid by the government in unemployment benefits/lower tax revenue • Weakening pound which would lead to imported cost push inflation from products with price inelastic demand such as oil • Loss of manufacturing skills meaning no choice but to continue importing goods in the future / deficit will persist
explain two likely benefits of economic growth.
More employment opportunities/lower unemployment • Increase in real disposable income. Therefore, consumers can afford to buy more goods and services and/or have more leisure time - i.e. an increase in living standards • Retail sales increasing. Therefore, higher profits for companies which may be used to improve the quality of products or to produce new products • Increased tax revenues for the government which may be used to improve public services or redistribute incomes and/or reduce budget deficit • Higher profits may lead to higher share prices leading to the wealth effect and/or higher dividends leading to more consumption • If there is export-led growth, then the current account of the Balance of Payments would improve • Real economic growth increases LRAS and could lower inflation
What are the limitations of using CPI?
No person is average - the goods in the 'average shopping basket' will apply to very few people because everybody has different spending patterns. Therefore it may lack accuracy. Problems in collecting the data - there are always problems collecting the data from the CPI surveys, e.g. recording errors, lack of staff training. Changes in the composition - the CPI has to change in composition every year to reflect changes in taste and habit. This means it's never truly comparable over time, e.g. in 2012 tablet computers were added and colour camera film dropped. Changes in quality, design and performance of products - the CPI only measures changes in price not performance. The price of a product may have risen but by comparison its performance may have risen much faster, e.g. PC's - these won't be reflected in the CPI. Changes in indirect tax - increases in VAT and customs duty increase the price of goods but they are not true price increases. Therefore this can distort the meaning of the CPI. Mortgage interest payments - the CPI excludes mortgage interest payments and rent. This means if it is used in wage negotiations wage increases may fail to take into account a large amount of household expenditure. Regional variations - the CPI is for the whole country but regional variations exist.
What are other problems of measuring unemployment?
Part-time workers - measurements of unemployment don't take into account unused resources. Part-time workers are counted as 'employed' not 'part-time unemployed'. In 2014 the working population of the UK was approximately 30m of which about 25% were part-time workers. Of those about 20% (1.5m) would like to have had a full-time job but couldn't find one. These are known as the 'underemployed'.
assess the economic effects of a deterioration of the balance of payments on current account.
Persistent and increasing net withdrawal (leakage) from circular flow of income may result in: • Loss of output (growth) • Loss of jobs (unemployment) • Possibly rising household debt to fund purchases of imported goods • Possibly a lack of investment as firms are concerned about the lack of UK non-price competitiveness • Threat of cost push inflation from the increased price of imports (increasing price of imports generated by a weakening currency). Evaluation • Impact will if the deterioration is long term • Impact will also depend if the balance of payments is in deficit and deteriorating or improving • If the current account is in deficit, then the capital account will have to be in surplus. • Reserves may have to be used to increase the capital account, but this cannot go on forever • A high level of foreigners buying domestic assets may be financing the current account deficit • A high level of borrowing, with high interest repayments, may be financing the current account deficit • Data may be inaccurate/difficult to collect therefore misleading
Comment on one policy the UK might introduce to improve its international competitiveness. (10 marks)
Plan - policy: investment to education and training schemes Why it promotes: increases skill level increases productivity→ increases MRP→ increases international competitiveness Why it may not work→ qualified workers may be attracted to jobs elsewhere which are better paying(easy since the EU allows movement freely) The UK economy has lost international competitiveness compared to other countries at the same level of development. One policy that could be introduced to improve the international competitiveness could be investment in education and training. Through subsidising education and training schemes, the government can help improve the skill level of workers in the UK and as a result the productivity also increases. The increase in the level of productivity will mean that the MRP, which is the change in revenue resulting from employing one extra worker. Increased labour productivity means that a firm can produce the same amount of products but at a lower cost. Productivity is usually considered a key factor in increasing international competitiveness, this is because as labour becomes productive, the costs fall and as a result firms are able to lower prices to be able to compete in the international market. Another benefit of investing in education and training is that the workforce becomes more flexible and mobile, it will reduce barriers that prevent workers from changing jobs. This will ensure that a worker is employed where their skills will be best utilised. A more skilled worker force also leads to higher living standards as more people will be in employment and will be able to consume more goods and services. However this policy does have some drawbacks, for example as workers gain more skills and qualifications, they may be attracted to better paying jobs in other countries and as a result the UK may see a brain drain. Due to the free movement within the EU labour is able to move freely between the countries. We have seen a inflow of low skilled labour from countries in the EU and as a result the unemployment rates in the UK rose. UK workers find it hard to find employment therefore they may move to find work elsewhere.
Distinguish between short and long run economic growth. (4 marks)
Short run economic growth relates to increases in Real GDP whereas long run economic growth relates to increases in an economy's productive capacity. Short run growth is generated by increases in AD or SRAS (when there is spare capacity) whereas long run economic growth is determined by increases in the quantity and quality of factors of production. In other words, short run growth refers to a movement towards the PPF whereas long run growth involves an outward shift of the PPF.
Distinguish between the deficit and the debt. (4)
The budget deficit is when government expenditure is greater than government revenue arising from tax revenue. The debt, is the accumulated value of the budget deficit. The debt is always larger than the deficit. The budget deficit is the annual excess spending over taxation, whereas the debt is the total excess spending over a period of time.
Why is the ILO survey figure always above the claimant count figure?
The claimant count excludes certain groups, e.g. men over 60, everybody under 18. Sampling and response errors in the survey. Some people may be out of work but not claiming benefit, e.g. stigma attached to claiming it, people may be unemployed for short periods and it's too much trouble to fill in all the forms, tight criteria applied to eligibility
Describe what is meant by the economic cycle.
The economic cycle refers to the regular fluctuations in economic activity. The economic cycle has four distinct stages. One of them is the recession, which is where GDP falls and unemployment rises. Next is the recovery stage. This is where GDP growth turns from negative to positive but is below trend growth rate. After this it is the boom stage where unemployment falls and GDP growth is above trend. Finally, it is the slowdown stage where GDP growth falls towards trend.
Explain how a fall in unemployment could occur at the same time as a fall in the employment rate. (4 marks)?
The employment rate is the total number of people in work, divided by the labour force. The key reason to a fall in unemployment and a fall in the employment rate is due to a rise in the population. As there is an increase in the number of consumers in a country, consumption, which is a component of aggregate demand will increase. This will shift AD right along the AS curve. This results in an increase in real GDP, which means there is an increase in employment. This means that more jobs are created, causing a fall in unemployment. However, at the same time, there is a rise in population, which means that the labour force is also increasing, which means that there is also a fall in the employment rate.
Define the national income multiplier and explain what determines its size. (4 marks)
The national income multiplier is the process by which any change in a component of aggregate demand results in a final greater change in real GDP. The size of the multiplier is determined by the size of the leakages from the circular flow of income. Thus the higher the leakages (savings, taxes and imports expenditure?), the smaller effect of the multiplier on real GDP.
explain two possible ways in which changes in the world economy could cause the movements in the oil price shown.
There could be a booming global economy which pushes demand for oil up, raising price There could be a recession and collapse in global demand, lowering demand for oil and hence price • Up to end 2010 demand for oil recovers mainly from developing countries such as China and India, raising price • 2011 Arab spring threatens supply of oil and/or stocks are bought up/speculative buying raises demand for oil, raising price
the Capital and Financial Account
This records capital inflows and outflows. It's made up of three types of transactions - direct capital investment including FDI, portfolio investment in stocks/shares and bonds, and lastly banking flows ("hot money"). The balance on the capital and financial account should be equal and opposite to the current account balance, so the balance of payments always balances. In reality, the capital and financial account always contains a 'balancing item', which represents errors and omissions in the figures
Distinguish between trade creation and trade diversion. (4 marks)
Trade creation is the replacement of high cost trade with low cost trade as a result of economic integration. Trade diversion is the replacement of low cost trade with higher cost trade as a result of economic integration. Trade diversion increases revenue received from tariffs, whereas trade creation decreases revenue received from tariffs. Moreover, trade creation increases consumer surplus, but trade diversion reduces consumer surplus. Trade diversion increases producer surplus for domestic firms while trade creation reduces it. Trade creation is the removal of barriers whereas trade diversion is the erection of barriers.
explain two ways by which the employment situation in the economy
Unemployment particular problem for young people, new to job market therefore policies intended improve employability of young people such as government spending on education (1) • National labour policy isdesigned to remove barriers to employment for young people such as the requirement to have experience • remove barriers to employment for young people like remove language barriers (must speak English) • Unemployment higher in groups with low levels of professional qualifications therefore investment needed in training provide by Government or subsidised for private firms • Labour market failing to recruit most suitable workers therefore, lower productivity meaning lower real output and employment more regulation required • Informal working no incentive for firms to invest in training and education lowering productivity therefore employers need to regulated to ensure formal contracts issued • Dominance of short-term, informal contracts reduces job security and productivity increases size of unofficial economy and reduces tax receipts, reducing investment in education
Assess the likely costs of rapid economic growth in a country such as Brazil
Unequal distribution of benefits of economic growth and a widening gap between rich and poor • Inflationary pressures due to capacity constraints • Unbalanced growth (EG export driven, primary sector) • Increasing mechanisation leading to rising unemployment • Profits may be transferred overseas (withdrawals from circular flow of income) • Increased imports of goods (withdrawals from circular flow) • Rural to urban migration may create asset price inflation in cities • Developed economy problems such as obesity, alcohol and recreational drugs
Evaluate the likely costs of sustained high levels of unemployment on the economy.
Waste of resources causing Poverty and inequality • Increase in government budget for benefits with low tax receipts • Social effects (e.g increased crime, increased suicide) • net migration of more skilled workers, especially the younger workers (decreasing potential labour force and potential output) • Deflationary spiral • AD falling, lower real output and falling average price level • AS falling, lower real output and higher average price level rising • Phillips curve - lower inflation and higher unemployment EVALUATION Higher unemployment may reduce inflation thus make the economy more competitive internationally • Higher unemployment may reduce wages and costs for business improving efficiency and international competitiveness • Contraction of inefficient sectors may make economic growth more a balanced • Time scales - risk of deflation and stagflation may only be short term
Explain two possible causes for a fall in disposable income
Weak aggregate demand maintaining unemployment • Cuts to public sector employment • Decline in manufacturing sector employment • Rising unemployment, highest in North-East of England • Lower productivity increases in UK than in other countries • Falling value of the £ • Inflation • Low union power - unable to keep pace with inflation • Increase in income tax • Reduction in welfare benefits
Explain the distinction between income and wealth
Wealth is value of a household's assets minus its liabilities (debts owed) Income is disposable income available for spending (personal income less taxes) An increase in net wealth makes a household more likely to spend and less likely to save at each level of disposable income A decrease in net wealth makes a household less likely to spend and more likely to save at each level of disposable income -home, cars, furniture, savings accounts, bank accounts Liabilities - student loans, car loans, mortgage, credit card balances (1)
explain the term "rate of interest"
cost of borrowing • price of money • income from savings deposited in a bank • return on deposits in high street banks • the interest payments on mortgages or credit cards or an overdraft • return on private loans made • Bank of England rate (not target rate)
assess the likely impact of a fall in house prices on the economy
identification of negative wealth effect (2); explanation and analysis (4): e.g. fall in confidence; lower consumption; fall or less rapid rise in AD; resulting in fall in real output or slower rate of economic growth. Fall in prices so easier access for first time buyers/extension of demand. impact on current account of balance of payments; or for impact on the price level; or for impact on unemployment. Evaluation: • Houses are a significant component of wealth and effect a large proportion of households in the UK which will therefore have a major effect in slowing down the recovery • Significance of elasticity of AS curve • Consumption is approximately 2/3 of aggregate demand which implies a strong inter-relationship • A fall might have a very large impact (more so than a slow down) and with bankruptcies/defaulting could lead to a large increase in supply and a further fall in house prices (and therefore AD) • Wealth effects take some time to trigger spending changes • Other factors may be more important in generating confidence such as the strength of the global economy's recovery • Regional differences in impact
assess the effect on the economy of the rise in oil prices
oil is a factor of production / costs of production rise and that inflation occurs = cost-push inflation • this could lead to a rise in unemployment as Aggregate supply and/or aggregate demand falls so real output will fall • Worsening of balance of payments on current account/trade balance through an increase in the value of oil imports • Rising costs of production for firms may lead them to reduce investment causing further falls in the AD and AS and hence the real output • Negative effect on income distribution as price rise is regressive / could result in fuel poverty EVALUATION • The extent of the effect on the balance of payments on current account depends on the PED of oil. Oil is likely to have a low PED leading to a significant worsening of the current account balance. • The effect being offset by technological change/use of substitutes • Supply chain, stocks and fixed price contracts may mean price rise is not felt immediately • Different effects on different industries • Dependency on oil may be falling due to deindustrialisation / increasingly service-based economy, and/or increasing use of renewable energy sources • Magnitude of price increases • Extent of other factors offsetting this effect (questioning ceteris paribus) • Length of time oil price remains high for and timescale of the effects
Using aggregate demand and aggregate supply analysis, explain the likely impact on the equilibrium price level and level of real output in the UK of the 'sharp increase in oil prices'
oil is a general production cost which increases when oil price rises the total value of an oil importing country's imports might rise and so AD shift to the left
Comment on the extent to which fiscal austerity is "reckless" for the UK economy (10)
the decreases in AD will have negative impacts on employment, output and income from Y-Y1. This could lead to a negative multiplier effect, which will have a detrimental effects on the economy. As unemployment would increase, due to fewer works required to produce lower levels of output, government spending on Job seekers allowance would increase, thus the budget deficit which means government failure would occur if the government do not achieve their objective of reducing the fiscal deficit in order to reduce to rate of debt accumulation. Additionally as extract 1 mentions, long term unemployment could cause skills erosion therefore reducing AS and reducing productive capacity of the economy therefore acting as a constraint on growth in the LR. This would cause deterioration in more than one area of macroeconomic performance which suggest the policy to be reckless. Also a decrease in real GDP could lead a decrease in the standards of living in addition to causing damage to confidence. In a time when confidence is already low in the economy this could lead to a reduction in both consumption and investment. However, fiscal austerity is regarded by many as necessary for the UK at the moment. This is because high levels of government debt interest repayments act as a constraint to government spending in the SR. There is a large opportunity cost associated if the government continue to borrow to finance spending and debt repayments increase (I-I1) there would need to be a reduction in government spending elsewhere in the economy, for example healthcare (H-H1). Therefore causing a decrease in living standards and possibly development. It can also be beneficial in the long run, despite being painful in the short run. If the government do not cut their payments of debt interest, they have limited finance to spend on capital investment, which will limit growth of AS, negatively impacting on future growth rates. Arguably the reduction in government borrowing would also reduce the crowding out effect as more funds from financial institutions would be available for private sector firms in order to fund investment in capital goods increasing AD in the SR and AS in the LR. It also depends on which taxes are increased and by how much. For example, if the government increased the basic level of income tax, this would cause a larger decrease in consumption than increasing the top rate of income tax as low income earners have a higher mpc than high income earners, causing a larger negative multiplier effect. In conclusion, the policy of austerity seems reckless. A keynesian approach such as that advocated by economist Paul Krugman may have stimulated recovery more quickly through direct government intervention in the form of increased government spending. However, it should be noted that reductions in the LR in debt interest repayments could free up government funding for either LR capital investment projects or to finance cuts in corporation tax or income tax in the future.
Assess the likely impact of deflation on the economy
• Deflation definition -It is normally associated with falling AD causing a negative output gap (actual GDP < potential GDP) Costs of deflation might include: • Consumers may postpone demand if they expect prices to fall further in the future. Reduced AD. • Firms may postpone investment and impact upon LRAS (as well as AD) • The real value of debt rises when the general price level is falling, consumer confidence and people's willingness to spend falls. • The real cost of borrowing increases: Real interest rates will rise if nominal rates of interest do not fall in line with prices. EG if Eurozone policy interest rates were to 0.5% in 2014 but realistically they cannot go any lower. If inflation is negative (deflation), the real cost of borrowing increases. • Deflation may increase unemployment -Phillips Curve • Lower profit margins: Lower prices can mean reduced revenues and profits for businesses - this can lead to higher unemployment as firms seek to reduce their costs by reducing labour (this in turn leads to reduced AD) • Confidence and saving: Falling asset prices in the housing market hit personal sector wealth and confidence - leading to further declines in AD EVALUATION • Low inflation can make an economy more competitive as prices rise more slowly than competitor countries • Net migration of workers can impact upon productivity • Depends upon how sustained deflation is - if only short-term can be a rapid re-adjustment of prices and this can be an advantage when AD recovers with higher growth and output • Low domestic demand may boost exports creating economic growth • "secular stagnation" - sustained low growth and low inflation
Analyse the reasons why the UK economic recovery is not sustainable (6 marks)
• High long-term unemployment, which is when workers are out of work for over a year. We will have a negative output gap (due to unused resources i.e the long term unemployed). Workers over time become deskilled and this causes structural unemployment. These people will struggle to get jobs in the future. We are not reaching our productive potential. • Recovery is consumer-led. Real wages have fallen, people cannot keep up with levels of former spending due to lower disposable income. As consumption is a part of AD. AD decreases and real GDP will fall. Recovery thus becomes short lived.
assess possible factors which may have contributed to changes in the rate of inflation
• Inflation defined - sustained increase in the average price level • Disinflation - falling rate of increase in average price level • Demand-pull inflation: This is when inflation originates from rightward shifts in aggregate demand (AD) • Cost-push inflation: This is when inflation originates from leftward shifts in aggregate supply (AS) supply-side inflation • If firms face a rise in costs, they respond partly by raising prices and passing the costs on to consumers and partly by cutting back on production • With cost-push inflation, output and hence employment tend to fall (demand-pull output and employment tend to rise) • Wage-push inflation is where wages are pushed-up, independently of the demand for labour • Import-price-push inflation is where import prices rise independently of the level of AD • Tax-push inflation is where increased taxation adds to the cost of living • The exhaustion of natural resources is where major natural resources become depleted and so their prices rise and the AS curve shifts to the left • Reasons for increase and/or reasons for decrease • Currency depreciation against USD increasing price of imports (imported inflation) • Growing trade deficit and weak currency importing inflation • Low labour productivity increasing costs • Dominance of unskilled labour and thus low productivity • Relatively high levels of economic growth creating demand-pull and cost-push inflation
Analyse the implications for the UK's austerity policy (6)
• Real wages are decreasing leads to reducing consumption. Job losses as people in e.g retail jobs lose jobs. Therefore government spending increases as benefits to unemployed • Low business confidence - Businesses move abroad - Unemployment rises - loss of income tax leads to increase in gov spending, benefits Identify and explain factors that are likely to have contributed to a fall in real wages over this period. • Decrease in productivity, lack of motivation to innovate or be productive - prices increase • Depreciation in currency leads to imports being more expensive so prices go up • Increase in taxes (austerity policy) - lead to increases in prices.
assess two possible causes of the increase in the rate of unemployment.
• reduced government spending, falling AD and output linked to lower employment • "austerity" fiscal policies • cuts in public employee wages, falling AD and output linked to lower employment • lower pension payments and unemployment benefits, falling AD and output linked to lower employment • budget cuts in previous protected areas like education • lower AD, falling average prices and real output thus lower employment • higher income tax, falling AD, falling average prices and real output thus lower employment • higher purchase tax (SRAS) falling output, rising average prices and lower employment • data reference (EG rate doubled between 2007 and 2013) • Lower subsidies (Extract 2) increases costs for firms and reduced SRAS (in long term may reduce LRAS) • supply-side factors (Extract 2) include structural problems of hiring/firing workers, as well as regulation hindering business start-up and growth • Accurate diagram showing decrease in AD or decrease in SRAS causing decrease/increase in average price level and fall in real output Long term deficit reduction more important than short term unemployment • Damage to economy as a whole from reduced potential output can be inflationary in the long term • Long term unemployment can reduce productivity of labour as workers become de-skilled • Reduced unemployment benefits may increase incentive to work. • growth is relatively high thus might expect to see unemployment fall in the near future • Long term impact may be to reduce real wages, make exports more price competitive and unemployment may fall • Low AD and low inflation may make Portugal's goods more price competitive, reducing unemployment in the long term • Decreasing regulation may worsen working conditions and increase job insecurity, lowering productivity
