IB Economics Macroeconomics

Evaluate government supply side policies to deal with cost push inflation.

All aim at improving the efficient supply of goods and services. These might include: •Privatisation •Imparting training and improving the education level of the workforce resulting in higher skills. •Increase competition in all industries by removing entry barriers, thus leading to more efficiency.

Changes in long-run aggregate supply.

As economic growth occurs the LRAS curve shifts to the right representing an increase in the potential output of the economy. For Keynesian economists, increasing LRAS depends on initial equilibrium position of the economy. An increase in LRAS for New classical viewpoint will cause increase in full employment level and a fall in the price.

Distinguish between equity and equality.

Equity- fairness taking into account their circumstances Equality- where everyone is treated the same no matter what their circumstances

Explain how governments monetary and fiscal policy to alter level of AD in economy.

FISCAL: set policies relating to spending and taxation rates, direct taxes(taxes on income), indirect taxes(on goods and services) MONETARY: set of official policies governing supply of money in economy and level of interest rates in economy.

Neo-classical LRAS.

LRAS curve is perfectly inelastic at full employment level of output. Output depends on quantity and quality not pricing.

Explain and draw a Lorenz curve.

Line of absolute equality indicates a perfectly equal distribution of income where N% if the population earns N% of the income. The further away a country's curve is from the line of absolute equality, the more unequal the distribution. (see diagram in notes)

What is a producer price index?

Measures changes in the prices of factors of production in order to predict future inflation.

Define national income.

Measures the monetary value of the flow of output of goods and services produced in an economy over a period of time.

3 measures of national income.

Most commonly used measure of countries national income is GDP. 3 different methods to calculate this: 1. The output method (measures actual value of goods and services produced) 2. The income method (value of all incomes earned in economy) 3. Expenditure method (measures value of all spending on goods and services)

Illustrate AD movements and shifts.

Movement: change in average price levels Shift: change in any of components of AD.

Define and distinguish between gross national product(GNP) and net national product (NNP).

NNP=GNP-Depreciation (capital consumption)

Distinguish and give examples of progressive, regressive and proportional taxation.

PROGRESSIVE: •main way to redistribute income from higher to lower income earners. •As income rises, people pay a higher proportion of income in taxes. •Usually certain amount of income that is non-taxed. Amount over, % of income paid to gov. •Tax deductions allow people to reduce their "taxable income" REGRESSIVE: •proportion of income paid in tax falls as income rises. •Indirect taxes are regressive taxes. •Good source of government revenue and might discourage consumption of demerit goods •worsen income inequality PROPORTIONAL: •proportion of income paid in tax is constant for all income levels. •Makes it simpler to not have huge complex tax system. •reduces error and manipulation which cause gov. earning less revenue than expected. •disincentive effects of taxes on working •high tax rates discourage people from working hard, moving into higher paid jobs as reluctant to lose own gains to higher taxes.

Define unemployment.

People of working age who are without work, available for work, and actively seeking employment.

Define deflation.

Persistent fall in the average level of prices in the economy. Two types "good" (improvements in the supply side of economy and/or increase in productivity. Increase in long-run AS, increase in real output and fall in price level) and "bad" (fall in AD/AS illustrate fall in AD resulting in a decrease in price level and a decrease in real output).

Define Inflation.

Persistent increase in the average price level in the economy usually measured through the calculation of a consumer price index (CPI).

What is the source of government revenue?

Primarily from taxes (direct and indirect), as well as from the sale of goods and services and the sale of state-owned (government owned) enterprises.

Impact of automatic stabilizers.

Progressive tax system and unemployment benefits, which are influenced by the level of economic activity and national income, automatically help stabilize short-term fluctuations.

How unemployment rate is calculated.

Rate of unemployment is the number of people who are unemployed expressed as a percentage of the total labour force.

Define and distinguish between nominal GDP and real GDP.

Real GDP=Nominal GDP adjusted for inflation.

Supply-side policies

Reduction in income taxes, reductions in corporation taxes, reduction in trade union power, reduction or elimination of minimum wages, reduction in unemployment benefits, deregulation, privatisation, education and training, research and development, provision of infrastructure, improved information.

Define disinflation.

Reduction in the rate of inflation.

Describe using a diagram, demand pull inflation.

Result of increasing AD. Due to changes in components of AD (see notes for diagram).

Describe, using a diagram, the circular flow of income between households and firms in a closed economy with no government.

See notes

Describe, using a diagram, the circular flow of income in an open economy with government and financial markets, referring to leakages/ withdrawals (savings, taxes and import expenditure) and injections (investment, government expenditure and export revenue).

See notes

Use a diagram to explain the determination of equilibrium output in the short run.

See notes.

Describe using examples the meaning, causes and solutions of frictional unemployment.

Short term unemployment when people are in between jobs or have left education. Natural unemployment. SOLUTIONS: •Lower unemployment benefits to encourage unemployed workers to take jobs available •making unemployed more willing to work shifting AS to right •Improve information from potential employers to people looking for jobs.

Explain the uses of national income statistics.

Shows: •economic growth (is an increase in national income over time) •develop policies •develop models of economy to make forecasts •performance •identifying changes in consumption, investment •evaluate living standards •basis for comparing different countries

Evaluate government exchange rate policies to deal with imported inflation.

This involves increasing the value of currency to reduce imported inflation. Increase currency rate will also lead to fall in demand for exports (component of AD).

Why is rate of inflation measured?

To eliminate the effect of sudden swings in the prices of food and oil for example.

Define Aggregate supply.

Total amount of goods and services economies produce at every given price level.

Define short run aggregate supply SRAS.

Total amount of goods and services produced at every given price level when the price factors of production do not change. Upward sloping.

Define aggregate demand

Total spending on goods and services in a period of time at a given price AD=C+I+G+(x-m).

Distribution of unemployment.

Typical disparities between: graphical, age, ethnic differences, gender.

Impact of fiscal policy on potential output.

Used to promote long-term economic growth (increases in potential output) indirectly by creating an economic environment that is favourable to private investment, and directly through government spending on physical capital goods and human capital formation, as well as provision of incentives for firms to invest.

Problems in measuring inflation.

• different income earners may experience different rates of inflation when their pattern of consumption is not accurately reflected by CPI •do not accurately reflect changes in consumption patterns and the quality of the products purchased • Could be errors in the collection of data as impossible to collect prices of all items bought by all households in all possible locations. • Statisticians try to take into account changes in consumption habits, making it hard to compare different time periods. • Countries measure it in different ways • Prices may change for variety of reasons that are not sustained e.g. seasons.

Factors affected by fiscal policy.

•AD and level of economic activity AD=C+G+I+(X-M) •Pattern of resource allocation •Distribution of income

Distinguish between absolute and relative poverty.

•Absolute poverty: does not have access to the basic necessities needed to sustain life •Relative poverty: living standards are well below an observed "average" in an economy

Discuss why, in contrast to the monetarist/new classical model, increases in aggregate demand in the Keynesian AD/AS model need not be inflationary, unless the economy is operating close to, or at, the level of full employment.

AD can increase such that there is an increase in level of real output without increase in price level as the spare capacity in economy is used up. (See diagram).

Identify the equilibrium level of national income/output.

Aggregate demand is equal to aggregate supply.

State the 3 phases of the Keynesian LRAS.

1. AS perfectly elastic due to existing spare capacity 2. As economy reaches potential output and spare capacity is used up, production becomes more expensive, upwards sloping (smooth curve) 3. When economy reaches full capacity, impossible to increase factors, LRAS perfectly inelastic.

Types of government expenditures.

CAPITAL EXPENDITURE: spending on goods and services intended to create future benefits, such as infrastructure investment or research spending. CURRENT EXPENDITURE: expenditure of the government which does not result in the creation of assets or reduction in the value of its liabilities. For the normal running of government departments and maintenance of services. TRANSFER PAYMENTS: financial assistance given to sections of the society in order to uplift or maintain their standard of living.Governments use such payments as means of income redistribution by giving out money under social welfare programs such as social security, old age or disability pensions, student grants, unemployment compensation, etc.

Causes and consequences of poverty.

CAUSES: •low incomes (situation tends to be cyclical) •Unemployment •lack of human capital CONSEQUENCES: •Low living standards. •Lack of access to sufficient health care. •Low levels of education. •Excluded from economic, social and cultural activities.

Changes in components of aggregate demand.

CONSUMPTION: •changes in personal income taxes (and hence disposable income) •changes in interest rates •changes in wealth •consumer confidence •level of household indebtedness INVESTMENT: •interest rates •technological changes •business expectations •business taxes •level of profit •levels of corporate indebtedness NET EXPORTS: •income of trading partners •exchange rates •level of protectionism •rate of economic growth •domestic producer efficiency GOVERNMENT SPENDING: •political priorities (improve public services, defence) •economic priorities •rate of economic growth •unemployment/inflation •tax revenue

How to measure inflation.

Consumer price index (CPI). Choose what is known as a representative "basket" of consumer goods and services and measure how this basket changes over time. These baskets are put into categories. Categories are given a weight in the index to reflect their importance.

Shifts in LRAS.

Curve will shift to right if there is an improvement in the quality of the factors of production or an increase in the quantity of the factors of production →improvements in efficiency →new technology →reductions in unemployment →institutional changes

Distinguish between a budget deficit, a budget surplus and a balanced budget.

DEFICIT: more spending than revenue SURPLUS: more revenue than spending BALANCE: equal spending and revenue

Consequences of government policies to deal with inflation.

DEFLATIONARY FISCAL: •Time lags •difficulty of fine tuning. DEFLATIONARY MONETARY: •increase in interest rates slows economic growth and negatively affects exports due to increase in exchange rates SUPPLY SIDE: •aim increase long term competitiveness and productivity (only long run).

Distinguish and give examples of direct and indirect taxes.

DIRECT: •imposed on peoples income or wealth or firms' profits. •Form of employment income, interests on savings and dividends from the ownership of shares. •Such taxes are unavoidable. Can be used as a mechanism to redistribute income. INDIRECT: •also known as expenditure taxes, or consumption based taxes. •Tax on goods and services. •Vary the rate with necessity and value of goods.

Define the two main categories of unemployment.

DISEQUILIBRIUM: occurs when there are conditions that prevent market from "clearing"(reaching the labour market equilibrium). EQUILIBRIUM: (natural unemployment) number of job vacancies in economy =number of people looking for work. Jobs exist but people are either unwilling or unable to take jobs available

Distinguish between a decrease in GDP and a decrease in GDP growth.

Decrease in GDP where the economy actually gets smaller, decrease in GDP growth where the economy continues to grow but at a slower rate.

Describe using examples the meaning, causes and solutions of seasonal unemployment.

Demand for certain workers falls at certain times of year mainly due to climatic seasons. •Encouraging people to take different jobs in their "off season"

Define Gini coefficient.

Derived from the Lorenz curve and is a ratio of the area between the line of equalit and a country's Lorenz curve A and the total area under the line of equality A+B. The higher the Gini coefficient, the more unequal is the distribution of income.

Reason for market system not distributing income equally.

Due to unequal ownership of factors of production.

New classical economists view of macroeconomic equilibrium in the long run.

Economy will always move towards its long-run equilibrium at the full employment level of output. Impact of any changes in aggregate demand will be on the price level only. Initially economy is at long-run equilibrium at Yf. When AD increase from AD1 to AD2 in short run, increase in output from A to B. Experience Inflationary gap where economy is in equilibrium at level of output that is greater than full employment level of output. However this is only possible in short run. This causes the price level to increase from P1 to P2. Means all prices in economy have risen as firms bid up prices of factors of production. Cost of production rises. Shift in short-run AS from SRAS1 to SRAS2. So reduce output back to Yf. Return to full employment level but at higher price level P3.

Keynesian economists view of macroeconomic equilibrium in the long run.

Equilibrium level of output may occur at different levels. Believe that the economy may be in long-run equilibrium at a level of output below the full employment level of national income (Yf). When AD is AD1 equilibrium will occur at a real output level Y1 and average price level P1.

Define and distinguish between gross national product (GNP) and gross domestic product (GDP).

GNP=GDP+net property income from abroad (income earned from assets overseas) GDP= C+I+G+(X-M) Unlike Gross Domestic Product (GDP), which defines production based on the geographical location of production, GNP allocates production based on ownership. It is the total income that is earned by a country's factors of production regardless of where the assets are located.

Distinguish between GDP and GNP/GNI as measures of economic activity.

GROSS DOMESTIC PRODUCT (GDP): •value of final goods and services produced within a country in a given period •It is the total of all activities in a country, regardless of who owns the productive asset. GROSS NATIONAL PRODUCT (GNP/GNI): •market value of all products and services produced in one year by labour and property supplied by the residents of a country.

Define fiscal policy.

Government policy that attempts to influence the direction of the economy through changes in government taxes or through some spending.

Two main instruments of fiscal policy.

Government spending and taxation.

Explain the meaning and significance of "green GDP".

Green GDP= GDP-environmental costs of production. Measure of GDP that takes into account any environmental costs from the production of goods and services.

Difficulties in measuring unemployment.

Hidden unemployment: 1.Consists of people who have been unemployed for long periods of time and have given up the search for work 2.Those who have part-time work but would prefer to work full time 3.Those who are woking in jobs for which they are greatly over-qualified.

Discuss why, in contrast to the monetarist/new classical model, the economy can remain stuck in a deflationary (recessionary) gap in the Keynesian model.

In keynesian model, market can have equilibrium level output below full employment level output. In New classical, long run equilibrium always returns to full employment level of output.

Relationship between income flow, expenditure flow and output flow.

Income flow=expenditure flow + output flow

Define economic growth.

Increase in real GDP over time

Explain the importance of improved productivity for economic growth.

Increases real output.

Costs of unemployment.

TO UNEMPLOYED PERSON: receive less income, lower standards of living, person who remains unemployed for long periods of time subject to high levels of stress, anxiety and depression, relationship break downs, suicides. Deterioration of human capital as they lose skills and become demotivated. TO SOCIETY: places where high levels of unemployment can see in form of poverty, homelessness, higher rates of crime and vandalism, increase gang activities TO ECONOMY AS A WHOLE: Production possibilities curve can be used to illustrate key problem, possible output operating at point within its production possibility curve. Opportunity cost of the government's spending on unemployed benefits, if more unemployed people government earns less in direct and less taxes and will need to spend more money to solve the social problems created by unemployed. Less investment.

Use PPC curve to explain how a movement from a point inside a PPC curve to a point on a PPC curve illustrates economic growth.

•At a, economies resources are not being used to fullest extent. •If increase in AD then deflationary gap would be removed and there would be an increase in real output. •This is the equivalent of movement from a to b. •Increase in real output is an increase in real GDP, so there has been economic growth. •Caused by factors including reduction in unemployment and increases in productive efficiency. (SEE DIAGRAMS IN NOTES)

Define components of AD.

•C=consumption on durable (consumed over long period of time) and non durable goods (consumed over short period of time) •I=Investment on replacement investment (spend on capital in order to maintain productivity) and induced investment (spend on capital in order to increase output) •G=Government spending •x-m=net exports=exports (domestic goods bought by foreigners)-imports(goods and services bought from foreign producers)

Describe the role of central banks as regulators of commercial banks and bankers to governments.

•Control nation's money supply, availability and cost of credit, and foreign-exchange value of its currency. •Regulation of availability and cost of credit altered to influence distribution of credit among competing uses. •Principal objectives to maintain monetary and credit conditions at high level of employment and production, reasonably stable level of domestic prices, and adequate level of international reserves. •Setting official interest rates

How to fix budget deficits.

•Cutting spending and/or •raising taxes •Deficits must be financed by borrowing money. •Interest must be paid on borrowed funds, which worsens the deficit.

Describe using a diagram the meaning, causes and solutions of cyclical (demand deficient) unemployment.

•Cyclical downturn in the economy CAUSE: •In slower periods, AD fall as consumer spends less causing demand of labour to fall (see diagram) SOLUTIONS: •Government can intervene to bring about an increase in aggregate demand through the use of fiscal or monetary policies ••Increase AD by increasing government spending, or lower direct or indirect taxes to increase consumption of households.

What are the types of causes of inflation?

•Demand pull •Cost push •Demand and cost push together •Due to excess monetary growth

Evaluate Government policies to deal with different types of unemployment.

•Depends upon the type of unemployment involved. •frictional, structural and seasonal unemployment ONLY be solved by supply-side policies. •Demand-deficient unemployment may be fixed by expansionary demand-side policies. •Use of demand-side policies may have bad effects elsewhere in the economy,e.g. if interest rates are lowered, may lead to inflation and fall in exchange rate. •no guarantee that expansionary monetary policy will be effective in raising AD •If consumer and business expectations about the future are pessimistic, then lower interest rates may not necessarily lead to increased AD.

Use PPC curve to explain how an outwards shift in a PPC curve and an outward shift in LRAS illustrates economic growth.

•Economic growth established through increasing the full employment level of output or potential output. •Increase in GDP as result in LRAS equivalent to outward shift of PPC. •Caused by increase in quantity and quality of resources. (SEE DIAGRAMS IN NOTES)

Five major objectives of macroeconomic policies.

•Economic growth: A steady rate of increase of national output •Full Employment: A low level of unemployment •Price stability: A low and stable rate of inflation •Satisfactory balance of payments •Equal Income distribution : An equitable distribution of income

Describe using a diagram, demand pull and cost push inflation together.

•Economy near full employment, increase AD results demand pull inflation, increase price level. •Higher price means higher costs of production, workers negotiate higher wages further increasing costs of production shifting SRAS (see notes for diagram).

Describe using a diagram, inflation due to excess monetary growth.

•Excessive increases in money supply by government are cause. •Increase in money supply results in higher AD. •Since economy rests at full employment, such increase causes price level to increase (see notes for diagram).

Evaluating National income statistics.

•GDP is a measure of the value of production in terms of market prices •indicator of economic activity, not a measure of a nations overall welfare •unreliable show of an economies health as it: →excludes nonmarket production (household services of homemakers) →legal versus illegal activities →not necessarily a good measure of well being of nation →says little about environmental quality of life →not necessarily reflect purchasing power →different countries have different conventions

Costs of deflation.

•HIGH LEVELS OF CYCLICAL UNEMPLOYMENT: →AD is low businesses likely let workers go, may lead to deflationary spiral as prices fall consumers put off purchase of durable goods i.e. deferred consumption, further reducing AD •BANKRUPTCIES: →Higher costs to debtors →value of debt rises, if profits low make difficult for business to pay back loans •OTHERS: →Reduce consumer confidence →Less investment (business make less profit, lay off workers, low business confidence)

Disadvantages of economic growth.

•INFLATION RISKS: →demand greater than supply causing prices to increase •LIVING STANDARDS: →Longer working hours due to increase in demand •DISTRIBUTION OF INCOME: →Inequalities may widen →some industries will be benefiting while others are suffering •SUSTAINABILITY: →Environment, negative externalities of production arise from producing a higher output of goods and services

Evaluate government demand side policies to deal with demand pull inflation.

•These policies highly unpopular DEFLATIONARY FISCAL POLICY: •involves an increase in taxes and lowering of government spending •Increasing taxes will result in lower disposable income for household and thus less consumption. •increased taxes will result in lower profits for firms and thus less investment by firms •lower the AD in the economy. DEFLATIONARY MONETARY POLICY: •involves rising of interest rates and reducing money supply •Higher interest rates mean higher loan and mortgage repayments •This will discourage households and firms to borrow, leading to fall in consumption and investment respectively

Explain and illustrate the business cycle and its phases.

•In developed country economies generally see a pattern where there are periods of rising growth, followed by periods of slowing growth and even falling growth. •Cycle periodic fluctuations in economic activity measured by changes in real GDP. •The long term growth trend is the potential output of the economy. •Phases: boom, trough, recovery, recession •RECOVERY PHASE: →economic expansion with GDP increasing at a rising rate →mainly driven by increase in AD •BOOMS: →increase in demand can result in increase price, can lead to increase in AD hence increase in average prices →inflationary pressure will build up and rate of growth of GDP will fall as economy nears its potential output •RECESSION: →defined as two consecutive quarters of negative GDP growth that is falling GDP →Fall in AD, fall in employment, low demand leads to lower inflation rates (even deflation) •TROUGH: →output cannot continue to fall for ever as always be some people with jobs to maintain a given level of consumption

Explain the limitations of using national income statistics.

•Inaccuracies unrecorded or under-recorded economic activity •external costs (resource depletion, pollution) •other quality of life concerns (people may be earning higher incomes but not enjoy higher standards of living, not account free activities such as volunteer work) •composition of outputs (large part of countries output is in goods that do not benefit consumers such as defence or capital goods)

Explain the importance of investment for economic growth.

•Investment in PHYSICAL CAPITAL key to economic growth as it enables workforce to produce consumer goods more efficiently. •Improvement in technology will lead to more goods being produced from available resources. The country will have achieved a higher gross domestic product. •Investment in HUMAN CAPITAL by improving quality of existing workforce leads to increase in productivity and optimum utilisation of resources. Done through education, training and healthcare. •Investment in NATURAL CAPITAL by discovering new sources will add to the total output of the country.

Consequences of inflation.

•LESS SAVING →if interest rate adjusted for inflation, real rate of interest will be negative, better to spend as saving has less purchasing power •DAMAGE TO EXPORT COMPETITIVENESS •GREATER UNCERTAINTY: →firms be discourages from investing due to uncertainty associated with inflation •REDISTRIBUTIVE EFFECTS: →Misallocation of resources away from productive assets. →Labour unrest (occurs if workers feel that their wages and salaries are not keeping up with inflation)

Advantages of Economic growth.

•LIVING STANDARDS: →better →Less unemployment, growth stimulates more jobs •CURRENT ACCOUNT OF BALANCE OF PAYMENTS: →sustained GDP growth boosts tax revenues and provides the government with extra money to improve public services such as education and healthcare →It makes it easier for a government to reduce the size of a budget deficit •INCREASE INVESTMENT: →rising demand and output encourages investment - this sustains growth by increasing long run aggregate supply •INCREASE CONFIDENCE •SUSTAINABILITY: →innovation and research and development, resulting in more efficient production processes to reduce costs (increase sustainability) •VIRTUOUS CIRCLE OF GROWTH

Consequences of unemployment.

•Loss of GDP •loss of tax revenue •increased cost of unemployment benefits •loss of income for individuals •greater disparities in the distribution of income.

Evaluate the use of government policies to redistribute income.

•Many agree government's obligation to ensure citizens enjoy a "reasonable" standard of living. •Some argue against government active role as interferes with market forces and results in inefficiencies in allocation of resources. •If firms have to pay insurances and social security costs for workers then this will encourage firms to hire fewer workers, thus contributing to unemployment. •High taxes discourage entrepreneurial activity and have negative effects on overall growth in economy due to disincentive effect.

Describe using examples the meaning, causes and solutions of structural unemployment.

•Permanent fall in demand for a particular type of labour •often results in long term unemployment as people do not have necessary skills to take on new jobs •People could be living in a different area to where the jobs are (lack of graphic mobility) CAUSES: •New technologies •lower cost labour in foreign countries •change in consumer tastes SOLUTIONS: •Long term education system training people to be more occupationally flexible •spending on adult retraining programs •give subsidies to firms to provide training •government provide subsidies or tax breaks to encourage people to move to other areas •Reduce unemployment benefits.

Explain how governments can alter the distribution of income through the use of transfer payments.

•Provide different types of assistance to groups in the economy to improve their living standards. •Payments made to increase income of particular groups within economy (child support, pension, unemployment benefit, payments to disabled people, subsidies to producers).

Explain how government can use tax revenue to provide goods and services for those on low incomes.

•Provide directly, or subsidize a number of goods and services that are socially desirable. •Tend to be goods and services that have positive externalities of consumption (healthcare, education, sanitation, water supplies). •Provision to ensure poorer embers of economy have access to essential goods and services.

What is taxation used for?

•Reduce consumption of goods that create negative externalities. •Reduce consumption of imported goods. •Raised or lowered to manage level of AD. •Control income inequality. •Finance government expenditure.

Describe contractionary fiscal policy using a diagram.

•Reduction of government spending and increase taxes as a measure to control inflation/AD. •Reduced government spending, AD fall reducing pressure on economic resources and the average price level come down. •Increased taxes takes away excess disposable income from households resulting in a fall in AD. •Used to reduce the inflationary gap(aggregate demand exceeds the productive potential of the economy.)

Describe using a diagram, cost push inflation.

•Result of an increase in costs of production. •Increase in costs results in a fall in SRAS, causing an increase in average price level and a fall in level of real output (see notes for diagram).

Describe using a diagram the meaning, causes and solutions of real wage(classical) unemployment.

•Trade unions and government interfere with minimum wages where trade unions negotiate wages higher than equilibrium •causes unemployment of a-b. (see diagram). SOLUTIONS: •Government reduces the ability of unions to negotiate higher wages (hard to do) •Minimum wages should be reduced or abolished (reduce income and living standards of workers who are already earning low wages, worsening distribution of income).

Describe expansionary fiscal policy using a diagram.

•Used to increase the AD in the economy. •If the economy is having a deflationary gap(resources are not being used in the optimum level and they are idle resulting in unemployment and low level of output) the government can use expansionary fiscal policy to reduce the gap or totally eliminate it. •Government will either increase spending (result in more projects funded increasing employment and output) or reduce taxes(more disposable income).(see diagram in notes)

Evaluate use of fiscal policy.

•ability to target sectors of the economy •direct impact on AD •effectiveness of promoting economic activity in a recession •time lags •political constraints →may conflict with other policies or political business cycles •"Crowding out" effect →when fiscal policy reduces investment spending •inability to deal with supply-side causes of instability •May cause inflation. •May cause change in interest rates.

Identify the four factors of production and their respective payments and explain that these constitute the income flow in the model.

•factors of production households provide to firms: →land →labour →capital →enterprise. •The firms, in return pay the factors of production: →wages →rent →interest →profit

Causes of economic growth.

•reduction in unemployment •increase in productivity •increase in quantity and quality of resources

Explain the causes of shifts in SRAS.

•resource prices •changes in business taxes, subsidies and supply shocks