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ECONOMICS THEME 2 - Coggle Diagram

- - - - Real GDP
        
        Nominal GDP does not distinguished between rises in GDP caused by the following:
        
        actual increases in output produced
        
        higher GDP caused by price increases
        
        Real GDP shows what GDP can 'buy' after adjusting for changes in prices over time
        
        Real GDP = nominal GDP x price level in previous year / price level in current year
        
        EXAMPLE: if nominal GDP increases from £2000 to £2200 billion and price level has risen from 114 to 120 over the same period, then:
        
        Real GDP is £2200 billion x 114/120 = £2090 billion
        
        real economic growth is £2090bn - £2000bn / £2000bn x 100 = 4.5%
        
        Real GDP - Value of GDP adjusted for changes in the price level
        Economies Growth - the percentage change in GDP over a period of time (normally a quarter of a year or one full year)
    - - Per Capita GDP is the average income per person in an economy
        
        FORMULA - per capita GDP = total GDP (in £s) / population level
        
        A higher GDP per capita increases the population's standard of living
        
        GDP cam also be expressed in terms of volume and value:
        
        volume of output: quantity of items produced in an economy
        
        value of output: market value of items produced (i.e. volume x selling price)
      - Other national income measures
        
        Gross national income (GNI) includes output/income earned by a country's resources, even if located outside the home country
        
        National happiness - measures of wellbeing include surveys measuring a population's happiness and adjust economic data to take this into account
        
        As incomes rise, we would expect happiness to rise but this is not always closely correlated
        
        Income inequality often results in less happiness even if average incomes are rising
        
        Surveys used to measure happiness and wellbeing are limited by subjectivity
    - - Purchasing power parity
        
        Limitations of GDP to compare living standards
        
        Real GDP per capita is used to compare living standards:
        
        between countries
        
        over time
        
        When comparing countries, PPP exchange rates should be used for comparing data expressed in different currencies
        
        Comparing living standards between countries and over time
        
        When comparing living standards between countries and over time, other issues include those in the following table
        
        Distribution of income
        
        Looks at how income is shared out
        
        A country with high income inequality has more people with incomes significantly below the average GDP per capita than one with a more equal distribution of income
        
        High levels of income inequality make GDP per capita less reliable in measuring living standards
        
        Composition of GDP
        
        Military spending (which directly benefits few people) can be a significant percentage of GDP
        
        Some contributions to GDP - e.g. spending on health and education - increase the living standards more than others contributions
        
        Shadow economy
        
        2 more items...
  - - - Calculating UK inflation using the consumer prices index
        
        The price level, measured by the consumer prices index (CPI), is the average level of prices at a point in time - represented as an index number
        
        Inflation is the % change in the CPI, e.g. if it increases from 100 to 103 over one year, the inflation rate is 3%
        
        The CPI calculates an average level of prices based on prices for a range of goods and services
        
        The CPI is a weighted average. Goods and services that households spend more of their income on - e.g. food and transport prices - are given a higher weightening
        
        Limitations of CPI in measuring the rate of inflation
        
        It does not include all goods and services
        
        It requires updating as spending patterns change, meaning we are not comparing like with like
        
        It represents the typical household, making it unlikely to represent individuals entirely accurately
        
        It takes no account of improvements to products over time, just their price changes
    - - Retail price index (RPI) includes the cost of mortgage repayments in the price index
        
        RPI is more volatile and affected by interest rate changes
      - caused by excessive increases in AD
        
        caused by AD rises that are needed to generate 'full employment' output
        
        Demand-pull inflation can be reduced by:
        
        reducing government spending
        
        raising taxes
        
        raising interest rates
        
        Demand-pull inflation
        
        Causes of inflation
        
        Effects of inflation
        
        Policy response
        
        Uncertainty
        
        2 more items...
        
        Interest rate are likely to rise to reduce inflation
        
        Cost-push inflation
        
        Caused by increases in production costs (i.e. decreases SRAS or AS)
        
        Increases in production costs are caused by:
        
        increases in wages, material costs, power costs
        
        increases in indirect taxes. e.g. VAT
        
        falls in the exchange rates (leading to 'imported inflation')
        
        Cost-push inflation is accompanied by falling GDP (and rising unemployment)
        
        Cost-push inflation can be reduced by:
        
        higher interest rates - leading to exchange rate rises
        
        improvements in labour market flexibility, e.g. reduction in trade union power
        
        Growth of the money supply
        
        Some economists (monetarists) believe all inflation is the result of excessive growth in money supply
  - - - Two main measures of unemployment are used in the UK:
        
        claimant count includes those receiving benefit payments for being unemployed
        
        Labour Force Survey includes those looking for but unable to find work, whether or not they are receiving benefit payments - this measure is consistent with the international measure of the International Labour Organisation (ILO)
        
        Those of working age are classed as:
        
        economically active - either employed or unemployed
        
        economically active - those in full time education, unable to work, retied or choosing to stay at home, e.g. to raise a family
        
        Underemployment is not classed as unemployment - despite the underemployed not being able to work as long as they would choose
        
        Underemployed - those in employment who wish to work longer hours
      - Changes in employment, unemployment and inactivity
        
        Significance of increased employment
        
        Increased incomes
        
        Rising living standards
        
        Improved skills of workforce
        
        Higher tax revenue as people work and spend incomes
        
        Significance of reduced unemployment
        
        Lower government spending on benefits
        
        Less disliking of population
        
        Closer to full capacity output
        
        Reduced social issues, e.g. lower crime, less mental and physical illness
        
        Significance of reduced inactivity
        
        Greater potential output
        
        Less labour shortages
        
        Higher tax revenue (if employed)
        
        Higher potential spending on welfare/benefits (if unemployed)
        
        Causes (or types) of Unemployment
        
        Seasonal unemployment - caused by decline in demand for seasonal workers
        
        Cyclical (demand-deficient) unemployment - caused by insufficient AD. This type of unemployment is reduced by increasing AD, through:
        
        lower interest rates
        
        lower taxes
        
        higher government spending
        
        Frictional unemployment - caused by people moving into and out of employment - is reduced by:
        
        improving information about job vacancies
        
        ensuring the welfare system does not create incentives to remain unemployed
        
        Structural unemployment - caused by:
        
        geographical immobility (regional unemployment)
        
        occupational immobility
        
        global factors, e.g. competition from low-cost producers overseas
        
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    - - Migration and employment/unemployment
        
        The effects of unemployment
        
        Unemployment contributes to:
        
        individual ill-health
        
        family breakdown
        
        higher crime rate (although this is disputed)
        
        Unemployment means an economy doesn't operate on its PPF.
        
        Unemployment causes a larger budget deficit due to:
        
        higher government expenditure on welfare
        
        less tax revenue collected
        
        Long-term unemployment can lead to deskilling of the working population (hysteresis)
        
        KEY TERMS
        Migration - the flow of people into and out of a country seeking employment and residential status
        Immigration - the flow of people into a country seeking to stay for the long term (to work/live)
  - - - KEY TERMS
        Balance of payments - a record of the financial transactions between the UK and the rest of the world
        Current account - a record of the trade in goods and services and flows of income between the UK and the rest of the world
    - - Trade in goods: export of goods minus imports of goods
        
        Trade in services: exports of services minus imports of services
        
        Balance of trade in goods and services = trade in goods balance + trade in services balance
        
        Primary income balance = net investment income flows:
        
        includes: interest, dividends and profits earned on overseas investments (less the outflows from foreign-owned assets based in the UK)
        
        Secondary income balance = net transfers of money:
        
        includes: private transfers between countries - e.g. overseas workers sending wages back to family in home country - foreign aid, grants and gifts
      - Current account deficits and surpluses
        
        Causes of current account deficits
        
        Exchange rate is high
        
        Relative inflation is high
        
        Relative productivity is low
        
        UK economic growth is high
        
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        Causes of current account surplus
        
        Exchange rate is low
        
        Relative inflation is low
        
        Relative productivity is high
        
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        The interconnectedness of economies through international trade
        
        Economies are interconnected in two ways:
        
        exports add to AD, to GDP and to job creation
        
        imports are connected to an economy's GDP level: higher income means more money to spend on imports (remember that one economy's imports are another economy's exports)
- - - - National income is the same as GDP
        
        National income can be measured in three ways:
        
        adding up all expenditure
        
        adding up all incomes
        
        adding up the value of all output produced
        
        The links between income and expenditure are shown in the circular flow model of the economy
        
        money flows from households to firms as expenditure
        
        money flows back from firms to households as income
    - - Income is a flow variable - measured over time
        
        Wealth is a stock variable - measured at a point in time
        
        Income adds to wealth if saved or used to buy assets - e.g. property - which will be held by the owner for some time
        
        Wealth falls if asset values decrease - e.g. a stock market crash - or assets are sold and the proceeds spent
  - - - KEY TERMS
        Injections - money entering from the circular flow of governments, businesses or the foreign sector
        Withdrawals - money leaving the circular flow either for savings, taxation, or spending on imports
  - - - macroeconomics equilibrium is reached in two ways:
        
        injections = withdrawals (in the circular flow of income)
        
        AD = AS
        
        At this equilibrium level there is no tendency for the level of real GDP or the price level to change
      - AS/AS and macroeconomic equilibrium
        
        Shifts in either the AD or AS curves will lead to new macroeconomic equilibrium positions
        Increases in AD:
        
        Increases in AD will normally result in either:
        
        an increase in real GDP
        
        an increase in the price level
        
        both of the above
        
        The closer to its full capacity output level, the more likely it is that an increase in AS will raise prices rather than raise GDP (and vice versa)
        
        Increases in SRAS:
        
        Increase in SRAS will normally result in either:
        
        an increase in real GDP
        
        a fall in the price level
        
        Increases in LRAS:
        
        Increase in LRAS will normally result in both rising GDP and a falling price level
  - - - Extra spending creates incomes for those receiving the spending, which creates further spending, and further income, and so on.
        
        Changes in spending lead to larger than proportional changes in national income because of the multiplier process
      - The Multiplier process
        
        Extra spending creates extra income, and so on.
        
        Not all additional income is spent, due to the withdrawals from circular flow
        
        Additional income is taxed, saved or spent on imports and is not 'passed on' as extra spending
      - KEY TERMS
        multiplier process - where a change in spending leads to a proportionately greater change in income
    - - the multiplier's size depends on how much of extra income is passed on as extra spending
        
        if higher proportion of income is spent, the size of the multiplier will be bigger
        
        The proportion of any additional income that is spent depends on the following:
        
        marginal propensity to tax (MPT)
        
        marginal propensity to import (MPI)
        
        marginal propensity to save (MPS)
        
        These marginal propensities are normally expressed as a decimal (i.e. 0.1 would be 10% of any additional income)
        
        The total of the three marginal propensities is called the marginal propensity to withdraw (MPW)
        
        the size of the multiplier is calculated as follows:
        
        1/MPW or 1/(1-MPC)
        
        EXAMPLE
        
        MPT = 0.2, MPM = 0.1 and MPS = 0.1
        
        investment expenditure increases by £100 Million
        
        The size of the multiplier is:
        
        1/(0.2 + 0.1 + 0.1) = 2.5
        
        The overall increase in income will be £100m x 2.5 = £250m
      - Significance of the multiplier for shifts in AD
        
        a change in AD changes national income by a larger amount - both increases and decreases
        
        The multiplier's actual size is uncertain - we can never be sure by how much national income will change when AD changes. For EXAMPLE;
        
        if the MPW is 0.25 (i.e. 75% of any additional income is spent), the size of the multiplier would be: 1/0.25 = 4
        
        if the MPW rises to 0.5, the size of the multiplier falls to: 1/0.5 = 2
        
        a change in government policy may result in an unexpectedly large increase or decrease in national income
        
        The result may have consequences for economic growth, inflation, and unemployment
- - - - Economic growth is cause is by:
        
        increases in AD (as long as the economy isn't already at full capacity
        
        increases in AS
        
        Increases in AD come from any of the following:
        
        Increases in consumption, caused by:
        
        lower interest rates
        
        lower taxes on incomes
        
        higher consumer confidence
        
        greater availability of consumer credit
        
        Increases in investment, caused by:
        
        lower interest rates
        
        faster economic growth (the accelerator affect)
        
        lower taxes on profits
        
        advances in technology
        
        higher business confidence
        
        Increases in Government expenditure, caused by;
        
        expansionary fiscal policy (deliberately increasing government spending)
        
        automatic stabilisers
        
        Increases in net exports, caused by:
        
        a fall in the exchange rate
        
        reduced trade barriers
        
        improvements in the competitiveness of export industries
    - - Actual Growth
        
        Caused by increases in AD
        
        Can be achieved through changes in government policy
        
        Measured by percentage increase in real GDP over time
        
        Caused by increases in any component of SRAS
      - KEY TERMS
        Actual growth - growth in real GDP caused by increased utilisation of unemployed factors (also known as short-term growth)
        Potential growth - growth caused by an expansion of an economy's productive capacity (also known as long-term growth)
      - Potential growth
        
        Caused by increases in economy's productive capacity
        
        Future actual growth is made possible by increases in potential growth
        
        Estimates of UK long-run growth are between 2% and 2.5% per year
    - - Increases in exports (falls in imports) increase AD
        
        Improvements in net exports generate actual growth
        
        Improvements in net exports also help the current account balance on balance of payments
        
        Improvements in export levels also have multiplier effects on the economy
  - - - growth in potential output means the economy can produce more
        
        If actual growth is lower than potential growth for long periods, potential growth may fall
    - - Actual growth diverges from potential growth resulting in output gaps
        
        Positive output gap: actual growth > potential growth
        
        unemployment probably falling
        
        inflation probably rising
        
        Negative output gap: actual growth < potential growth
        
        unemployment probably rising
        
        inflation probably falling
      - Use of an AD/AS diagram to illustrate output gaps
        
        Output gaps can show the level of spare capacity in an economy
        
        Output gaps can also be shown using AD/AS diagrams:
        
        negative output gaps: when AD is lower than the level needed to generate full capacity output
        
        positive output gaps: when AD is higher than the level needed to generate full capacity output (and is likely to lead to higher inflation)
  - - - Actual growth varies in a repeated, cyclical pattern - the *trade (business) cycle
        
        The four stages of the business cycle are:
        
        boom
        
        downturn
        
        recession
        
        recovery
        
        KEY TERMS
        trade (business) cycle - the repeated fluctuations in actual growth over time
        Boom - the period where actual growth is above average (and above the potential growth rate)
        Recession -the period where actual growth is negative for two consecutive quarters
    - - Features of recession
        
        Economic growth is very low or negative
        
        Unemployment rises quickly, reaching high levels
        
        Inflation falls, reaching low levels (with possible deflation)
        
        Low consumer/business confidence
        
        Budget balance moves further into deficit
        
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        Features of a boom
        
        Above average economic growth
        
        Unemployment falls, reaching low levels
        
        Inflation rises as economy 'overheats'
        
        High consumer/business confidence
        
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  - - - Increases in negative externalities
        
        Potential increases in inequality
        
        Natural resource depletion
        
        Increases in inflation
        
        Worsening current account balance
      - Benefits of economic growth
        
        Higher living standards
        
        Easier to find jobs for unemployed people
        
        Social indicator improvements - good for consumers
        
        Increased tax revenue for government
        
        Lower welfare expenditure for government
        
        Lower absolute poverty
        
        Status and Prestige for government
    - - Growth and living standards
- - - - Low unemployment
        
        Low and stable rate of inflation
        
        Balance of payments equilibrium on current accounts
        
        Balanced government budget
        
        Protection of the environment
        
        Greater income equality
  - - - Distinction between monetary and fiscal policy
    - - Interest rates
        
        Interest rates are set by Monetary Policy Committee (MPC) of the Bank of England
        
        These are used to affect AD (mainly through changes to consumption (C) and investment (I):
        
        increase in interest rates will lower AD
        
        decrease in interest rates will increase AD
        
        Asset purchases to increase the money supply (quantitative easing)
        
        Low interest rates do not always boost AD sufficiently and the Bank of England can use quantitative easing
        
        The Bank of England creates more money electronically, which is used to buy bonds from the financial sector, which then increases the price of bonds and lowers interest rates
        
        Commercial banks now have more money available to lend and, given the low interest rates, there should be more demand for borrowing from the private sector
        
        KEY TERMS
        Quantitative easing - where central bank purchases financial assets specifically to inject new money into the economy to stimulate activity
    - - Changes in government spending (G)
        
        Changes in taxation (T)
        
        The government's budget (fiscal) balance is the difference between government spending and taxation:
        
        budget deficit: G > T
        
        budget surplus: G < T
        
        Types of taxation
        
        Direct taxes are placed on incomes
        
        Income tax - paid on wages and salaries
        
        Corporation tax - paid on company profits
        
        Capital gains tax - paid on the profits made from trade in assets
        
        Inheritance tax - paid on inherited income
        
        Indirect taxes are placed on expenditure
        
        VAT - paid on most items of expenditure
        
        Excise duties - paid on various items, such as tobacco, alcohol and fuel
        
        Custom duties - paid on some imports
  - - - Market-based policies
        
        Cutting corporation tax
        
        Removing regulations
        
        Privatisation and deregulation
        
        Lower income tax - to encourage labour supply
      - Interventionist policies
        
        Improved education - to boost productivity and reduce labour immobility
        
        Improved infrastructure - to attract business and boost labour mobility
        
        Supply-side policies and AD/AS
        
        Supply-side policies (if successful) boost the productive capacity
        
        Increases in productive capacity are show by increases in AS (LRAS and Keynesian AS curves)
        
        Strengths of Supply-side policies
        
        Avoid conflicts with other objectives
        
        Increase productive capacity of economy
        
        Lower unemployment
        
        Not expensive (for market-based policies)
        
        Reduce economically inactive population
        
        Weaknesses of Supply-side policies
        
        Tax cuts often favour high earners
        
        Welfare cuts fall disproportionately on lower income earners
        
        Relative poverty increases
        
        Very long time lag with most policies
        
        Investment in infrastructure is expensive
        
        Policies to increase AD include:
        
        lower taxes
        
        higher government spending
        
        lower interest rates
        
        Policies and AD/AS Diagrams
      - KEY TERMS
        Supply-side policies - policies designed to increase the productive capacity of the economy
  - - - Potential conflicts and trade-offs between macroeconomic objectives
    - - A low rate of inflation moves along the short-run Phillips curve (SRPC) leftwards but only to a higher rate of inflation
        
        As unemployment falls, trade unions have more power to push up wages - especially as labour shortages emerge
        
        If wages rise, then inflation will also rise - the trade-off
        
        To reduce inflation, AD is reduced, and this leads to lower GDP and higher unemployment
        
        Once identified and used for policy purpose, the SRPC relationship seems to break down
        
        KEY TERMS
        Policy conflicts - where using a policy to achieve one objective moves further away from achieving another objective
        Trade-offs - Improvements in achieving one objective mean moving further away from achieving another objective
        Short-run Phillips curve (SRPC) - Shows an apparent inverse relationship between the rate of inflation and the ate of unemployment
    - - Economic policies may also conflict with each other:
        
        Low interest rates may conflict with expansionary fiscal policy
        
        High interest rates may conflict with contractionary fiscal policy
        
        Supply-side policies may conflict with expansionary fiscal policy
        
        Contractionary fiscal policy may conflict with (interventionist) supply-side policies
        
        As a result, we often refer to the overall 'stance of policies' - that is overall combined effect of fiscal, monetary and supply-side policies - as being 'loose' (expansionary) or 'tight (contractionary)
- - - - The AS Curve
    - - Movement along the AS Curve happens when the AD curve shifts
  - - - If production costs increase, the profitability of production falls. Leads to decrease in SRAS (leftward shift)
        
        If production costs fall, the profitability of production increases. Leads to increase in SRAS (rightward shift)
      - Factors influencing Short-Run AS
        
        These include changes in:
        
        Cost of raw materials
        
        wage rates
        
        energy costs (for power)
        
        indirect taxes, e.g. VAT
        
        the exchange rate (affecting import prices)
        
        worker productivity
  - - - Factors influencing Long-Run Aggregate Supply
        
        Technological advances
        
        Advances in technology will enable a firm:
        
        to produce more output
        
        to reduce costs of production
        
        Relative productivity
        
        Productivity measures the rate of production of output
        
        A country with higher productivity costs (relative productivity) than others will rise at a slower rate than other countries and it will be able to produce more
        
        Changes in education and skills
        
        Improvements in education and skills increase an economy's productive capacity
        
        improvements in skills level and the quality of education should lead to higher productivity
        
        increased education can reduce occupational immobility
        
        Changes in government regulations
        
        Investment in infrastructure - e.g. high-speed rail - can increase productivity capacity
        
        Changes to direct tax levels can change the incentives of workers to supply their labour
        
        Changes in welfare benefits can also create incentive for people to work
        
        Changes in how governments support businesses - e.g. through grants and tax changes - can generate more business activity
        
        Decreases in LRAS may occur if regulations increase costs for business
        
        Demographic changes and migration
        
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    - - an alternative AS curve to the SRAS and LRAS is the Keynesian AS curve
        
        At low levels, real GDP can be increased with no upwards pressure on prices
        
        As an economy gets close to capacity level, prices begin rising
        
        the Keynesian AS curve is perfectly inelastic at full capacity output and any increases in AD lead to higher price levels
      - Classical AS curve
        
        the classical AS curve is vertical, meaning any change in AD moves the equilibrium position to a different price level - with no change in the output level
        
        A vertical AS curve assumes that, in the long run, output will be always at the full capacity level
        
        Increases in full capacity output are achieved through long-run changes in the economy
        
        Shifts in LRAS curves
        
        a change in any of the factors influencing the LRAS will shift the curve leftward or rightwards
- - - - Components of aggregate demand (AD)*
      - KEY TERMS
        Aggregate demand (AD) - total planned expenditure at any given price level (C + I + G + (X - M))
        Consumption - Spending by households on consumer goods and services
        Investment - spending by businesses on additions to the capital stock of the economy
        Net trade - value of exports less value of imports
    - - Consumption rises and falls with increases and decrease in disposable income
        
        Disposable income that is not consumed will be saved (and vice versa)
        
        Link between disposable income, consumption, and saving is not always clear as households can finance consumption by borrowing or using past savings
        
        Other determinants of consumption include interest rates, consumer confidence and the wealth effect
        
        Interest rates
        
        Higher interest rates encourage saving - and vice versa
        
        Higher interest rates reduce credit-financed consumption - and vice versa
        
        Higher interest rates mean higher mortgage repayments, meaning less spending - and vice versa
        
        Consumer confidence
        
        the more confident households feel about future prospects, the more they spend on consumption
        
        Confident households are more likely to borrow money to finance more consumption
        
        Wealth effect
        
        Higher asset prices - e.g. for houses and shares - increase the wealth of households
        
        Households increase spending and borrow more against the value of these assets to finance consumption
        
        GOVERNMENT EXPENDITURE (G)
        
        The trade cycle
        
        the trade cycle can be summarised as follows:
        
        Changes in economic growth affect government expenditure
        
        Lower economic growth usually leads to higher unemployment, requiring more welfare spending (and vice versa)
        
        Governments often spend more when growth is low to boost AD
        
        Fiscal policy
        
        In Fiscal Policy, governments can deliberately change government spending (and taxation) to achieve economic change
        
        Higher government spending increases AD should lead to faster economic growth (and lower unemployment)
        
        Lower government spending decreases AD should lead to lower inflation (and lower economic growth)
        
        Government spending can also generate supply-side improvements
        
        NET TRADE (X - M)
        
        The trade balance, net trade, is the difference between the value of exports of goods and services (X) and the value of imports of goods and services (M)
        
        The trade balance can be either in balance (where X = M, or:
        
        in deficit, where X < M
        
        in surplus, where X > M
        
        Main influences on the trade balance
        
        Real income
        
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      - INVESTMENT (I)
        
        Gross net investment
        
        Net investment expands an economy's productive capacity by increasing capital stock, e.g. purchase of additional machinery
        
        Replacement investment does not add to capital stock but replaces parts of the capital stock that have worn out and need renewing
        
        Gross investment includes both net investment and replacement investment
        
        Rate of economic growth
        
        Investment is affected by economic growth. This is the accelerator process:
        
        Economic growth should lead to more investment as businesses expand productive capacity
        
        This allows businesses to produce more output to profit from higher economic growth
        
        Business expectaions and confidence
        
        Business confidence improves if businesses feel more optimistic about future sales and profits
        
        If confidence rises, businesses will invest more, anticipating higher future sales and profits
        
        Keynes and 'animal spirits'
        
        The economist Keynes believed investment was determined partly by 'animal spirits' - the beliefs/instincts of managers deciding whether to spend on investment goods
        
        The decisions are based on managers' feelings about the future of the economy
        
        Often animal spirits move collectively - a herd instinct emerges and investment will significantly rise or fall due to these collective 'spirits'
        
        Demand for exports
        
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