Changes to the PPC

Economic growth shifts to the right by the PPC due to various cause means that there is economic growth. Not only in terms of the quantity but quality as well. This means that more goods can be produced at a faster time.

Economic growth shifts the PPC to the right

Causes:

- More resources (e.g. more workers, mineral discoveries…)- Better resources (e.g. better education, technical progress…)- Improved efficiency (e.g. from technology)

Result = more of both goods can be produced

5 aims from the government:

1. Economic growth

We measure the total output of an economy by its gross domestic products (GDP). A rise in GDP indicates growth in the economy; this means;

- More goods are produced- More jobs & higher pay- Higher tax revenue & social spending- (Happier votes…!)

A fall indicates recession (or depression in extreme case) The UK target for growth in GDP is between 2-3%.

1ai. Between 1961 and 1973 Japan’s average yearly growth rate was the best at 9.6%.

ii. Between 1974 and 1979 Mexico’s average yearly growth rate was the best at 6.1%.

iii. Between 1980 and 1989 Japan’s average yearly growth rate was the best at 4%.

iv. Between 1990 and 1999 United States’ and Mexico’s average yearly growth rate was the best at 3%.

v. Between 2000 and 2007 Mexico’s average yearly growth rate was the best at 3%.

1b. On the evidence shown on this table, Mexico’s GDP has grown faster than Germany between 1961 to 2007. It was matching Mexico between 1980-1989 at 2% GDP but since then Germany has slowed down on economic growth to 1.6% whereas Mexico’s GDP has sped up to 3%.

1c. UK’s poor performance is clearly shown between 1961 to 1979 where UK’s GDP was on average over 1% less in GDP compare to its nearby nations until between 1980 onwards where UK is matching if not becoming better than France, Germany and Italy.

2. Low Unemployment

This means lost output & poverty for some:

- Fast growing economies have low unemployment levels- Slow growth/recessions raise unemployment

- Technology replaces workers … need economic growth to keep unemployment down

2a. The economic performance between 1995 to 2007, UK had a higher GDP growth to the Eurozone in all years except three where in 2000, Eurozone had a higher GDP and in 2006 and 2007 where they were matching each other. The biggest gaps between UK and the Eurozone is in 96, 02, 03 and 04 where the GDP difference was over 1%.

2b. The UK’s unemployment was lower than Eurozone between 1995 to 2006 because of many factors. One of those factors is that there’s a boom in terms of GDP particularly between 2000 to 2004. This means that there are more jobs available for the people to work meaning less unemployment. There could be political reasons behind it. It’s argued with the reign of Tony Blair around that era, it was Thatcher like in terms of economic policies such as tax cuts which means that more people are motivated of becoming wealthy so more trade which means higher GDP. It could be international as well such as they secured a major deal with USA for example on something which boosts trade but I don’t know what happened back then.

3. Low Inflation

Inflation is the rate of change of average prices. This causes consumers to have lower disposable income meaning that they can spend less. High inflation damages the economy. Hyperinflation destroys the economy (Events like this happened in Germany, Russia, and Zimbabwe). The target rate for the UK is 2.5% (+ or – a half a percent).

4. Balance of Payments

Every import means that money leaves the UK. To pay this, we must export goods to foreigners – money flows into the UK. The aim is to export as much as (or more than) we import; this gives a “balance (or surplus) on the current account”. A deficit means that imports exceed exports; over time, this creates major problems…!

3a. The London bombings in 2005 effect the economy in the short term by the major cancellations during the days after the bombing and during that year (600,000 visitors fewer) as one of the key elements of going to London is missing which is safety and if it isn’t safe and there’s a higher risk of an injury or a fatality, you’ll never go there regardless of everything else. This meant that there were a lot of refunds to be made and that planned exports aka money goes away and therefore the GDP in that year decreases.

3b. In the long term, unemployment levels rise quite dramatically as tourism is one of the biggest money makers that the UK produce meaning that 2.8 million jobs have been cut no only directly but a chain reaction of other jobs so indirectly as well.

Economic Objectives So the 4 key economic targets are:

- Low inflation- Low employment- High economic growth- Balance on the current account (ideally a surplus but that doesn’t happen in the UK

anymore)

Labour governments have pursued a “more equitable distribution of income” as a 5th target. Protecting the environment is another possible target.

Protecting the environment is another possible target for now and the future.

4a. The four objectives are to raise employment levels so that there will be a rise in investment. Plus, to keep low taxes and inflation as long as possible. Finally, to tackle the wealth divide of the nation and make the country a fairer and more prosper environment. He also spoke about the natural environment and meeting objectives.

4b. There was evidence shown when the person spoke about how statistically that the British economy is one of the strongest in the world beating “Japan and even America” in 2007 and they predict that this will keep growing at this rate according to the speaker. However, on the environmental side, they’re haven’t been meeting their objectives meaning that they need to turn it around and that will cost short-term investments which will lead to long-term gains. (The person who predicted the economic growth in England to increase in 2008 and 9 got it extremely wrong as there was a severe economic recession in 2008).

Macro-economic policy

- Governments attempt to “steer” the economy- Classical view: economy moves naturally towards maximum growth & full employment

when markets are allowed to operate freely (Adam Smith’s fundamental idea).- Keynesians: believe that government needs to “manage” the economy – to maintain

Aggregate Demand (John Maynard Keyne’s fundamental idea).

Recent influences:

- Sound public finances – government doesn’t over borrow- Care for the environment- A more equitable (fair) distribution of income (for Tories less likely to do that)

Trade-offs

In the short term, governments can’t hit all four targets at once:

- Some economic aims might be sacrificed for others in the short term- …but a sound economy should help hit all 4.

The strength of the economy will depend on 4 factors of production:

- Land - natural resources- Labour - number, skills & mobility of workers - Capital - infrastructure & investment - Enterprise - business acumen of the population

The office for national statistics (ONS) measures GDP in the UK. Changes in GDP can be distorted by inflation; we need to measure “real” GDP. For this, we use index numbers.

Terminology Employed:

- Gross Domestic Product – GDP- Value of the total economic activity in the economy

- Real and nominal measures- Nominal GDP measured in money terms- Real GDP measured in money terms minus inflation

National Income Accounting

- Statistical record of what goes on in an economy- An index number allows us to make comparisons over time and with other countries- Index number 100 given to the price in the base year

Commodity Year 1 price Base Index Year 2 price IndexA 5p 100 10p 200B 12.5p 100 15p 120C £4.00 100 £3.00 75

To get the average index number you add new index numbers then divide by 3. 395/3 =131.6 this means on average it’s increased by 31.6%.

Problems with Indices:

1. Becomes out of date

- Pattern of consumer spending changes over time – RPI must change the weights it attaches to different commodities - RPI must also take account of the new goods coming on to the market

2. Quality changes

- Index does not record quality changes only price changes for example the quality of TV’s has been improved over the years - This is true of a large number of products - In real terms their price has actually fallen - Index overstates the price increase

3. Special offers

- Index does not record special offers or purchases in the unofficial economy

Other measures of price changes

RPIX – underlying rate

- Underlying (target rate) of inflation = RPIX = RPI – mortgage interest payments- Governments target rate of RPIX – used by MPC is 2.5% + or – ½ %- Mortgage payments removed – easier for the UK to compare its inflation rate internationally- Mortgage interest payments are affected by the ROI- Up Rate Of Interest (ROI) to down inflationary pressure will increase the RPI

RPIY

- RPI minus mortgage interest payments, local authority taxes and indirect taxes

Aggregate Demand and Aggregate Supply

What is aggregate demand and supply?

Aggregate demand shows the total demand for every product in the economy. This is the same for supply but total supply in the economy.

Here’s an example of an aggregate demand chart. This has a very similar shape to an individual’s price and quantity graph. This is because almost always it’s like this for many products and because of how many are like this. It doesn’t take into account those anomalies. The one difference that instead of the x-axis being called quantity, it’s called, real national output. On this particular graph it shows the difference between year 1 and 2.

As the aggregate demand is pretty much the same as a demand curve. The aggregate supply is very different and debated though the two main different types of economists.

This diagram is a Keynesian aggregate supply curve (government controlling the economy). They believe this is the curve due to the wages being fairly stable up to full employment and afterwards rise up dramatically as less and less people can do the job.

Here’s the classical view of the short run aggregate supply curve. The difference here is that in the short run wages. Remain flat and

the prices of the other factors in the economy are fixed. They believe in the short run, that firms

can pay for overtime meaning that there output is increased slightly. This will lead to the employees getting a raise overall (not by much). However, the increase of demand will change the real output moreover than the

slight wage increase. The changes on this graph show when year 1 is the base year that in year 2, the line dropped meaning a fall in costs and year 3 it’s visa-versa.

The Economic Cycle

There are four phases:

Boom -

- GDP grows quickly- Consumption is high- Unemployment is low & falling – may see labour shortages- Inflation pressure especially if growth > 3%

Downturn/ Recession -

- GDP growth slows- Unemployment may start to rise- Consumers aren’t spending as much because they want to save for their needs &

inflation starts to fall depending on the duration- Recession = 2 successive quarters of negative growth

Depression -

- GDP may become negative- Unemployment is high and rising and as well for the individual the risk of being

unemployed is high- Consumption is low; firms won’t invest and develop because of sales- Inflation is low (or negative)

Recovery -

- GDP recovers and start to rise again- Consumption starts to rise as confidence returns- Unemployment starts to fall (may be a time lag)

Negative output gap

- Below 2.5% GDP- Unemployment- Below trend line

Positive output gap/ Inflation

- Above 2.5% GDP- Where the economy can’t keep up the demand

Examples of effects of the UK economy?

Eurozone countries experience a boom: Positive output gap because the Eurozone has more money available to trade so that money could be potentially invested in the UK exports so the UK benefits alongside with the Eurozone. However, in the long term this could potentially be a bad thing because if they are making so much money. They could be building they own manufacturing industries at competitive prices meaning that the export could go down.

Crop failure in USA: Negative output gap due to the domino effect of food prices increasing particularly foods which depend largely on the USA crops. This means that the amount spent on foods will increase meaning that there is less money available to spent on other goods and how fragile the product is, it could cause major problems.

An Arab-Israeli war: Negative output gap because the war makes western civilisation as well as parts of Asia completely fragile due to the drop of oil supply meaning that the prices will rocket and oil is the base product of almost everything particularly transport. That’s why we developing new fuels to stop this inevitable problem.

A significant technological advance in food production: Positive output gap because whoever has that technology first will benefit the most because less time, money and resources are required to do the same thing in huge quantities. This means that they can spent a higher percentage of debt we have and other things which would take too long to explain about till the point where the other major countries have caught with this technology.

Bank of England raises interest rates by 5%: Negative output gap due to the amount of borrowing we do so there’s a constant rise of debt. One of the reasons that debt is growing is that the chancellor of the bank of England has kept the interest rates at 0.5%. So this means that they’ll have to pay back ten times the difference as before and that will create a huge havoc with the system and this is one of the worst ways that can damage the people.

Rising unemployment fears: Negative output gap because people will cut their spending so that if they do turn unemployed they have their savings to survive for a period while they try to find another job. Furthermore as they cut their spending, the demand for most products will fall (some more than others e.g. perfume will fall more than shampoo).

Sharp rise in house prices: Positive output gap due to there’s high demand in the market and that generally means that there’s an increase to the average person’s income meaning that the trade is flowing well if the supply for good houses can keep up with the demand and that’s when the economy is at its best when that happens (rarely happens nowadays).

Al Qaeda seizes power in the Gulf States: Negative output gap because oil is one of the most fundamental base products that we have to almost every product particularly in the transport sector as the price will shoot up by at least tenfold meaning a war to get rid of Al Qaeda and his occupants but without destroying the oil so that the supply can still be there.

China reduces its prices by 20%: Negative output gap due to that there will be no competitors which come close to the price meaning that there will be a huge extension of demand or if they’ve found a technique or resource which allows them to do that than a huge demand. People will buy a lot more Chinese goods and the China will grow so quickly (it’s already growing fast to beforehand). This means that whatever products that we are making but also the Chinese are at a similar quality. Will fall which means that some manufactures will fall and could lead to the company turning bankrupt depending on how stable they are on the balance sheets.

Huge oil & gas fields discovered in North Sea: Positive output gap because depending on is we can make petrol than UK could turn into an Arab country in terms of wealth because it’s so valuable that almost everyone apart from people who live without technology and many man-made products need it. This could potentially repay some of the debt in the economy and give a huge boost to spending money into education, health, etc.

Circular flow, Consumptions & Savings

Circular flow diagram of Income

GDP = value of economic activity inside the UK

GNP = GDP + net earnings from overseas assets

Transfer Payments = money given without any corresponding economic activity. E.g. grants to students

Why measure national income?

National income measures output, expenditure & income of an economy. The statistics show totals & components.

- Economists study them to learn how economy works- Government, firms & economists use them to make forecasts and plan of the future

(e.g. government may plan to adjust taxes)- Comparisons can be made over time & between countries- Government can make judgements about economic welfare – growth usually means

rise in living standards- GDP per capita (per person) = GDP/population (economically active would be better)

Country Population (m) GDP (£m) Per capita (£)A 300 900 3B 120 480 4C 10 50 5D 240 360 1.5B2 40 320 8D2 80 240 3B3 80 160 2D3 160 120 0.75

This can be considered desirable the disparity between rich and poor due to the job market being very diverse, some are just manual labour to others which need to higher education and need a lot more skills so they should get rewarded for that.

Income is either spent or saved, and thus is the main determinant of consumption. As wages change, governments want to predict the effect of consumption. They do this by measuring Marginal Propensity (likelihood) to Consume (MPC) – how much of any extra income will be spent on consumption. The remaining money will go to Marginal Propensity to Save (MPS) MPC = (Change in consumption/change in income) If a £200 rise in income to a leads to a £150 rise in consumption then: MPC = 0.75 (£150/ £200). Any rise in income usually leads to a rise in consumption – the MPC is likely to be positive.

The Average Propensity to Consume (APC) measures the average amount spent on consumption out of total income. APC = (Consumption/income)

If total disposable income = 100 billion and consumption = 90 billion, then APC = 0.9.

In richer countries, the APC is less than 1 since we will save some income but in poorer countries. It’s one due to their needs not being supplied below 1 APC.

1(a). The relationship between the consumption and disposable income is that the higher the disposable income, the higher the consumption and you see this throughout the graph. Despite this, there is an exception which is from 1975 to 1976 where the consumption increased slightly but the disposable income decreased slightly.

Accuracy of National Income

The figures may be inaccurate because of:

- Statistical inaccuracies- Home-produced services – never come to the attention of the government.- Value of public sector services – difficult to measure- Income distribution – a few may earn most of the extra health…- Externalities – don’t appear in the figures- The ‘grey’ economy – cash-in-hand work…

4a. The incentive is crystal clear, the people doing this scheme want to minimise their official incomes to deduct as little money as possible by tax so they can keep more of their money in their pockets.

b. These types of people tend to do work in the economy than civil servants due to their methods being more ‘pay by cash’ than chequebook or salary transferred directly into your bank account, so the tax payer will know if you false advertising your income and hence the hidden economy is more lucrative to taxi drivers and builders rather than teachers and civil servants.

c. Creating more part time, casual jobs means that the tax people will find it much harder to uncover any hidden jobs by the people who are in the grey economy and so there will be more people going into the grey economy so it expands if part time employment grows.

Comparing income causes problems…

- Prices change – we have to adjust for inflation…- Government figures may not be accurate- Changes in population – need to calculate ‘per capita’ income- Quality of good improves – but is isn’t measured in GDP figures…- Defence expenditure – GDP was very high 1939-45… does this reflect living

standards?- Consumption & investment – diverting spending from investment to consumption

raises living standards now…but future growth will slow down(a) The more disposable income we’ve got, the more we spend in terms of total

consumption however the percentage barely changes and it be either down or up.

Year MPC APC1966 265.2-260.6 = 4.6/(275-268.8)6.2 = 0.742 (3.s.f) 265.2/275 = 0.964 (3.s.f)1976 1.4/-1.3 = -1.08 330.2/346.3 = 0.9541986 25.6/17.6 = 1.45 427.8/443.1 = 0.9651996 20.7/13.9 = 1.49 561.8/602.4 = 0.9332006 15.8/8.5 = 1.86 776/783.6 = 0.990

All correct (Good news)!

(ii). What’s happening is that the MPC is increasing every decade along with APC with the two drops which are 1976 and 1996. Apart from that it stayed with my conjecture that it is increasing throughout the years.

What is aggregate demand?

The total demand from every product.

What makes up aggregate demand?

Consumption: (C) … by consumers … all the goods and services bought

Government: (G) spending on services in the public sector

Investment (I) … in new factories, machines, new products

Exports (X) minus Imports (M)

This is due to a product being made abroad than in England.

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

M X I G C AD400 200 300 400 600 1100900 200 300 200 850 650400 500 100 250 1000 1450

X M I G CLast year (£bn) 600 400 300 200 400% change (+) 10 12 5 8 5

X M I G C ADLast year 600 400 300 200 400 1100This year 660 448 315 216 420 1163

If aggregate demand is too low… then unemployment occurs because there isn’t enough demand for every product to be profitable.

If aggregate demand is too high … inflation occurs.

Consumption creates the biggest sum of AD (around 70%)

The factors that effects consumption are when interest rates go down. This means that more people will spend on products which will benefit themselves in the long run and to those people who are already on a loan, their monthly repayments go down meaning that they have a higher disposable income level and to those people who save, the value for holding the money will go down so that further increases the chance of more people buying. It works the other way round as well. Consumer confidence is a factor as well when they look at today’s economy (so far it’s on the recovery).

Consumption + Savings

Income is either spent or saved, and thus is the main determinant of consumption.

As wages change, governments want to predict the effect on consumption.

They do this by measuring the:

- Marginal Propensity to Consume (MPC) = how much of any extra income will be spent on consumption.

- MPC= (Change in consumption) / (change in income)- Any rise in income usually leads to a rise in consumption, the MPC is likely to be

positive

Consumption is also affected by:

- Wealth – We spend more if we feel wealthier (e.g. house prices or share values rise).- Inflation – We buy more in the short run to beat inflation … but then may save and

invest money to protect its value.- Rates of Interest – Many pay monthly mortgage repayments … expensive durables

(cars, furniture) require loans: rises in rate of interest (RI) cuts borrowing & spending.

Looking Further Into Aggregate Demand

Aggregate Demand Curve

The changes of the Price level cause movements along the curve.

These are caused by:

1. Interest Rates – higher RI (Rate of Interest) raise the price of borrowing & spending.2. Change in wealth – higher prices make people poorer.3. Foreign sector – if UK prices go up; then exports goes down, imports goes up, real

national income goes down.

Q1. Economic theory could take into account this by seeing the relationship between inflation and Real GDP by stating that the higher the Inflation the lower the Real GDP meaning that it’s inversely proportional to one another. The reason is because of the fact that it costs more to get the same things prior to inflation meaning that there will be less trade altogether with our currency. Hence, we buy more imports and that makes us a poorer country.

Aggregate Demand Curve Shift

The shift in the graph to the left is showing that the aggregate demand falls at every price level and if it shift’s to right, the aggregate demand increases at every price level. However the price level doesn’t change.

Factors causing AD Curve to shift left:

- Interest Rates Rise – reducing consumption.- Rising Unemployment- Rise in Direct Taxes (Income Tax) (Consumption falls, Investment falls…)- Fall in Government Spending [AD = C+ I + G + (X-M)]- Fall in stock market values [-ve (Negative) Wealth effect]- Fall in business confidence (firms stop investing… lay-offs)- Rise in exchange rate [exports now dearer, so sales fall … imports look cheap, so

buyers don’t buy British (GBP)]

The reverse of all of these factors will push the AD curve to the right.

2 (a).The increase of investment will likely shift the AD curve to the right. That’s because the more investment into the economy, the more investment will occur meaning that there will be an increase of aggregate demand.

(b). The rise of interest rates will likely shift the curve leftwards due to that rise will affect the amount of borrowing we’ll do particularly for the banks with their exploitation of low interest rates at the moment of ½ percent to exchange millions possibly billions of pounds in borrowing and the rise depending on the amount could create a big shockwave or domino effect to other companies.

(c). The large cuts in taxes will like shift the curve rightwards because tax is the base expense towards almost anything (along with production costs but that’s irrelevant to this context) and that cut will give the consumers a higher percent of their income to spend. Furthermore, it’s a great time to spend because all the products will fall.

(d). The 50 per cent fall of prices in the FTSE 100 will dramatically shift the aggregate demand curve to the left. This is because the top 100 successful business in London overall halved their success. This is a big decline meaning that there’s far less trade around and in the international markets, if they invested shares into the business, there shares will be cut by half. This means that they’ll be poorer and they lose trust within the FTSE markets meaning that AD won’t be potentially recover as well as before because there will be less trade in large quantities. Also the negative wealth effect plays a key role where your asset value goes dramatically down.

(e). The fall in savings means that the AD curve will likely shift leftwards because logically where would does the difference in savings go? It goes into spending and in the economy that’s typically a good thin which means that there is more trading involved with products and the real national input will increase.

(f). The increase in government in education and healthcare will mean that the AD curve will shift rightwards. This is due to the increase in investment and if it’s by the government, then the investment will be huge. Looking further into it, for healthcare more people will be at work due to less illness around and technology and facilities will improve meaning that if you are ill then you’ll recover quicker than beforehand. If you invest in education, you can get like I said with healthcare, improve technology and the facilities, not only that but also looking at the longevity of the investment, the lower years will have a better education after it’s been established.

(g). When the Great British Pound (GBP) strengthens (in this case 25%) against all other currencies will shift the AD curve to the left. That’s because less foreign investors will buy British goods as every product manufactured by them costs 25% more expensive and that makes the company suffer particularly S.M.E’s which manufacture goods. When those who just surviving in the business have this problem to contend with, they’ll almost certainly shut down, that won’t change the total economy by much but the big companies suffer as well but the big brand are generally smart enough to think of other ways to make a profit such as Dunlop moving from their UK factory to South east Asia; however that still means that there will a high rise of unemployment.

As companies fall, consumers rise because we can exploit every other currency by buying products there. That’s what people were doing in the late 90’s to mid-2000’s on gadgets and moreover on holidays. I remember the days when I was 7-8 years old where it was over 2 euros to the pound and we went on holiday to the South of France and the difference between buying the product there than here was more than the transport to get there so it was the perfect trick to get high end products costing hundreds to thousands of pounds. Unfortunately technology wasn’t very good so we couldn’t exploit it as well if this happened today.

The Multiplier

A rise or fall in C, G, I or (X-M) will result in an even greater rise or fall in AD. This is called the multiplier effect.

We can see that at each stage, a proportion of income is spent on further goods, thus increasing AD and national income.

The reverse is also true – if Jean loses her job, all of this extra spending will cease! Demand falls by £965.

The strength of the multiplier depends on the Marginal Propensity to Consume – the lower the MPC, the lower the effect of the multiplier.

Governments have used spending to change national income, & thus Unemployment & inflation.

The reverse is also true: for any drop in C, G, I, or (X-M), the aggregate demand will fall disproportionately.

But:

- It’s difficult to measure the multiplier accurately- It takes time to work…- It’s usually low – between 1 and 2- The larger the leakages from the circular flow (S, T, M) the weaker is the multiplier

effect.

3) The multiplier effect will aid consumer spending by the town having good foundations of a tourist area such as it contains affluent historical buildings and it’s has great conservation areas and the employment is generally for tourists so the MPC should be higher than normal due to tourists spend more on souvenirs and extra features than a typical local would.

Formula: 1/1-MPC = 1/1-(MPS + MPT + MPM)

MPC: Marginal Propensity to Consume MPS: Marginal Propensity to Save MPT: Marginal Propensity to Taxes MPM: Marginal Propensity to Imports

The Accelerator Effect

This refers to Investment:

- When a rise in national income results in a proportionately larger rise in investment- Strong demand = firms expand production, running down stocks of finished products- As well as replacing worn out equipment, they may invest in capital goods to raise

capacity- So in a given change in demand for consumer goods causes a greater percentage

change in demand for capital goods

The Capital Output Ratio

The accelerator model works on the basis of a fixed capital to output ratio.

Formula: Capital/ Output

3:1, 1.5:1, 0.83(2.d.p):1, 0.67(2.d.p):1, 0.92(2.d.p):1 (All other way round!)

1. 1:32. 2:33. 5:64. 2:35. 12:13

Criticisms of the Accelerator

- Adjustment costs and Time lags: Installation, lost output, retraining: firms rarely move smoothly from one optimal size of plant & machinery to another)

- It ignores firms spare capacity & ability to meet a short term rise in demand (e.g. by outsourcing)

The accelerator effect is highest when:

- The rate of change of consumer spending is strongly positive (a boom environment)- Spare productive capacity for businesses is low- Available supply of investment funds is high

Aggregate Supply Curve

Short Run Supply Curve (S.R.A.S)

It’s a straight line and a shift the curve by:

- Wage rates- Raw material prices- Taxation (especially indirect taxes e.g. V.A.T)- Interest rates - Productivity (rise, it’ll go to the right and vice-versa)

Any big rise in these will cause a supply side shock, pushing the curve sharply up % left. A fall will increase supply, at lower prices.

Raising output means offering overtime… so raising costs & prices.

As GDP rises, there would be higher aggregate demand and firms would try and react to that and the firms will raise their prices to exploit and take a share of that money.

Exactly to opposite as firms will lower prices, cut some wages, make people redundant, etc.

1. If interest rates fall by 2.5%, then SRAS would shift to the right.2. If VAT falls by 10%, then SRAS would shift to the right.3. If unions win a 12% pay rise, then SRAS would shift to the left.

4. If Russia cuts off its gas supplies to Western Europe, then SRAS would shift to the left.

5. If there’s a war between Iran & Saudi Arabia, then SRAS would shift to the left.6. Ways of increasing productivity are to have competition schemes either good or bad.

To set targets to the makers over a certain time, increase in training, rearrangement in work

Long Run Supply Curve (L.R.A.S)

1. The curve shows us that no matter how big or small the price level is at, it’ll won’t change the real output. This graph also conclusively shows that we have reached the maximum efficiency within every corporation so we can’t increase total output at all (I totally disagree with this in every way but it is a theory which is completely debateable). I say this because there’s never at stage where it’s a 100% efficient the maths can prove that.

2. It’s meant by short run by the money wage rates and other inputs are fixed.3. It’s meant by long run by that everything can be changed within the businesses so

wage rates are not fixed.4. The PPF curve shows the same thing which is that we are at full employment.5. We can link this to the trend line by them again showing the same thing.

How can the LRAS shift to the right?

It can shift by technology, education and capital equipment.

Capital Equipment: Is the machines behind making the product.

Technology improves output by technology being the continual progress of mankind. We continual perfect, invent and improve objects that we can make so any significant progress in any of the main sectors will shift the curve to the right. For example, if we have found a new raw material which gives us electricity at a lower price and the quantity of this raw material is almost infinite than the supply curve will dramatically shift to the right because it affects every main sector in some way, shape or form. I’ll be more specific like the housing sector; there’s a consistent need for electricity from our cookers to gizmos that is on average, increasing due to more things being used digitally which requires electricity and as the conventional fossil fuels are gradually increasing as the years pass by, this new material will slash the prices of many products due to the quintessential cost being so much lower that consumers who couldn’t afford it prior now can.

Education improves output in the long run by more and more people knowing more topics and understanding more about the world we live in as well as outer space. This knowledge will help them to be more divergent in their situations and problems in oneself or in a group or a company. This then will help finding new ideas which could potentially work and be successful and the more of these ideas that you could have, ultimately, the better. Furthermore, the future generation will eventually own the companies of tomorrow (unless your company gets shut down) so they shouldn’t be stupid should they?

Capital equipment improves output in the long term by that equipment the building equipment of all mechanical products (unless they are naturally made). So if we improve the way the products made by making it faster or more economical in its resources then that helps build the end products better.

Aggregate Equilibrium

This graph shows us that the SRAS2 has shifted to the right which changes the aggregate equilibrium form E1 to E2.

The new equilibrium could be due to that the government has cut taxes by a significant percent or increased the subsidies at a sector. Interest rates could have gone down and therefore we can borrow even more money than before at the same interest price (particularly effects banks).

4 factors that cause the AD to change

Assume this is the full employment output:

2(a). LRAS hasn’t changed but the price level has risen.

(b). SRAS shifts massively to the left. Higher price level.

(c). Price level rises and that’s it.

LRAS

- Education and training - Capital Investment- Technological Improvements- International trade, allowing countries to specialise- Make efficient walk perceptive- Government

Equilibrium in short run

Equilibrium occurs at output OY & price level OP. Any rise in AD shifts the curve to the right…

Typical causes;

- Fall in interest rates- Fall in exchange rate- Fall in (income tax rate)

The equilibrium could change by the SRAS curve as well by…

- Rising wages- Rising taxes- Rising raw material costs

The reverse is also true in both cases.

a. If the workers were successful for demand of higher pay, that’ll mean wages go up, people would be wealthier unless the price level rises and so aggregate demand would rise shifting it to the right. Aggregate supply would shift to the right as they need to somehow keep their profit margins even in an increase of costs. If aggregate demand equals aggregate supply than just the price rises.

b. Consumption would go down, people would save more unless interest rates go dramatically down and aggregate demand would shift to the left.

1. The graph shows us that there’s a certain point of which regardless of the price level increase, the real output will be the same.

2. The graph goes vertical due to the point of which the real output is at its maximum meaning that it’s 100% efficient (at full employment).

3. AD1 curve’s state of economy isn’t very good due to the equilibrium being on the horizontal line meaning that it isn’t working at full employment and the unemployed won’t accept lower wages and this vicious cycle occurs unless the government steps in according to John Maynard Keynes.

4. Ways of government spending, education, healthcare, infrastructure.

Government Spending

Governments finance spending from taxes; spending plan is a budget.

Spending > Tax Revenue = budget deficit

Raises aggregate demand but the government must borrow the extra – raises national debt.

Spending < Tax Revenue = budget surplus

It reduces aggregate demand however, you can help pay off the national debt or save it.

Spending = Tax Revenue … broadly neutral effect, (very slight increase of AD). The reason is because some people save money however the government spends it.

Tax Revenue £m Govt Spending £m Budget Type Effect on AD200 300 Deficit Increases250 250 Neutral/ Balanced Slight increase500 400 Surplus Reduces450 550 Deficit Increases600 450 Surplus Reduces350 350 Neutral/ Balanced Slight increase

Cumulative effect on the national debt £50 million surplus

Economic Growth – Rise in LRAS (Long Run Aggregate Supply)

Any rise brings a fall in prices. Supply-side policies can raise LRAS.

Supply Side Policies

These aim to make the economy more efficient 7 improve supply: e.g.:

- Cut income tax

This means that the public can spend more money meaning that the aggregate demand goes up. This higher percentage of money that they now have is good because they can save or spend by their own free will (moreover). However the downside is that if the country is in national debt, it can’t be in such a national surplus with this cut than without it meaning that if interest rates goes up, then we will have to pay more to get rid of it and that means higher taxes. In addition it splits the wealth divide even further.

- Cut corporation tax

Likewise with income tax however it’s that firm’s profit shall be greater. The benefits to the firms are that they can invest more into their products or services; or R&D the object; or they can pay off their shareholders or give them a higher percentage to make them happier and maybe if it’s a high tier business, higher wages to the workers but that goes into a different realm. The disadvantages are likewise we income tax, the government can’t make such a surplus with the cut than without it meaning that these two tactics shouldn’t be used nowadays where we have pay out our national debt which is (in January 21st 2014) 1.26 trillion pounds. Furthermore, the owners get the biggest benefit so if there’s a grudge or allegations against the owner and he or she’s benefits then the moral isn’t very good. Going back to the finance if there’s a short to medium term change in the cut such as, if they’d increased the taxes back up to norm or beyond, then there’ll be an outrage because the firms have adapted these tax figures within their businesses and how to maximise it and all that work will go back down the drain and hence short term aggregate supply will go down.

- Cutting benefits

Awful to the one’s living on benefits or having their majority of money from benefits but for everyone else, it’s ironically beneficial. This is pretty much cutting costs minutely compared to the other two in terms of the money that the government saves (still hundreds of millions if it’s substantial enough). Out of the five this and privatisation are the most controversial because of the ways of doing these things. Unfortunately it isn’t as simple as cutting all benefits by X much.

- Privatisation

This helps by the government letting go of one of the leashes for the private equity firms or businesses to control and thrive on. This cuts time from the staff controlling it to concentrate on other areas, reduces costs and utilises the savings for something else. The only trouble is that they are generally small regional areas that they saving so it won’t change much compared to the other four because if they give away too much, then there could be a risk of a protest against and now the company is only maximising it for money rather than for something else for example.

- Training & education (more of a long term benefit)

This will barely help the economy in the short term in fact be worse of due to the substantial costs and time for people to learn and train; on the other hand if the money is being used efficiently then this will shift the LRAS the most due to the people knowing more about the world that they live in and apply what they learned into making more money for the government to take for the benefit to the nation. It’s a simple as that.

Keynesian Model

Economic growth will have a different effects depending on the initial position on the AD curve from no effect to inflation to the economy.

Ideal Effects of Investment (Classical Model)

AD shifts to the right, SRAS shifts to the right, LRAS shifts to the right to match the AD and SRAS new equilibrium.

4a. If earnings rise by 10% this will mean AD would shift to the right and SRAS will stay the same and hence LRAS will stay the same.

4b. If there’s an increase of government spending on education and training this will mean LRAS will shift to the right, AD will shift to the right and SRAS will stay the same.

4c. If there’s an increase of long run interest rates, this will mean AD falls

Economic Growth

To show economic growth, you could use a PPC (Production Possibility Curve) chart or the LRAS (Long Run Aggregate Supply).

Labour

- Demography, birth and death rates- Participation rate: parents with young babies, pensioners, students and people living

in benefits - Migration- Skills + Education + Flexibility + Mobility

Ways that the government can help encourage entrepreneurs:

- Better infrastructure e.g. better transport facilities, better communications, better training

- Reducing the paperwork for entrepreneurs- Increasing business education- Stable (non-inflationary) economic policies- Reducing interest rates- Lower taxes

Efficiency

- Efficient firms prosper – the inefficient fail- Governments encourage competition to improve efficiency- Some argue that markets fail, so government control needed (Keynesian ideas not

classists)

Four Distinctions

- Economic growth is measured by the Real GDP- GDP = volume of output x average price- GDP per capita = GDP/size of the population- Falling economic growth does not equal to shrinking economy (it’s still growing!)- GDP (Gross Domestic Product)

Factors not considered by GDP

- Unequal distribution of income- The black market (illegal trade)- Environmental damage- Crime + Violence- Sustainable relationships … etc.

Economic growth Vs the standard of living

The true quality of life may include:

- Material consumption- Access to health care- Access to education- Pleasant peaceful environment- Access to clean water- Access to good food- Freedom of association- Good transport- Good shelter- Freedom of speech- Up to date technology (depending on the persons preferences)

Instruments of Government Policy

Government tries to influence the economy with these tools:

Fiscal policy

- Tax: Raising taxes cuts consumption & vice versa (AD falls)- Government spending: Raising this increases aggregate demand & vice versa- Budget deficit: When government spending is greater than tax revenues, they

borrow this money and so to optimise this, the interest rates should be to the minimum. It may be used to stimulate the economy when unemployment is too high

- Budget Surplus: Is where the government will save money to do other stuff with it such as to pay off our national debt, it’s used to cool the economy when inflation is too high.

Expansionary fiscal policy

- B is past full employment meaning workers are paid overtime (1.5 to 2 times). This means inflation goes up meaning imports rise and export falls, this changes the balance of payments

- It could create higher economic growth and less unemployment but sacrifices inflation and balance of payments and vice-versa

Fiscal policy – supply side

- Low rates of tax- Low rates of benefits- Tax allowances lead to firms updating their capital equipment more regularly- New capital equipment – technology more advanced and productive

Monetary Policy

- Government changing the rate of interest or supply of money in the economy e.g. printing more money

- Since the mid 70’s dominant policy for controlling AD & inflation- Increase money supply & fall in rates of interest will raise aggregate demand- Decease money supply & rise in rates of interest will drop aggregate demand- Money supply = notes and coins + what we have in our bank accounts

They increase the money supply by:

- Government running a budget deficit- Commercial banks increasing their lending

Increase in money supply and spending power is likely to cause inflation

Government manipulation of the Money Supply

Changing the rate of interest and supply and demand for money and therefore aggregate demand makes it the main instrument of monetary policy.

An increase in the rate of interest should reduce AD as it:

- Increase cost of mortgages & loans, deceases disposable income, AD goes down- Exchange rates – Up rates of interests so higher demand for £’s- Higher demand for £ gets stronger and makes imports cheaper and lowers

inflationary pressure- Makes exports dearer – export earnings all reducing aggregate demand in the

economy- Cheaper imports means that more is likely to be spent on them – effect on BOP- Reduces exports so job losses in exporting firms further drop on AD- It affects firms expectations – consumer expenditure is likely to fall- Firms are less likely to invest because the investments that worked well in the past

may not work as well now due to the rate of interest being stronger- So an increase in the rate of interest is likely to reduce C+I+G+(X-M) and AD falls

Role of the Central Bank

- By keeping inflation low & stable, central bank stabilises output and jobs- At B, actual output is greater than sustainable output so RO will rise and Inflation

falls, the output gap is eliminated- At A, unemployment is below sustainable output so inflation falls- Bank of England will lower rates of interests so it’ll boosts growth in output and jobs

Role of the Bank of England in implementing monetary policy

- BOE sets ROI through its monetary policy committee- Chancellor of the Exchequer sets a target level of inflation- Monetary policy committee try to ensure that the target is hit- ROI needs to be changed 18-24 months before they have any effect on inflation- MPC estimates where AD is and projects the effect of this demand in the future- MPC alter ROI by small amounts to ensure AD kept on track and achieves target

Unemployment

Unemployment is where people who are looking for work but can’t find work.

There are two ways to measure unemployment. These are:

- Claimant count - Labour force survey

Full employment occurs where every worker willing to work at the prevailing wage has a job.

Some economists’ claim it is where less than 3% of the work force is out of work is full employment.

1 (a) (i). From 2005 Q3 to 2006 Q3 there’s an increase in unemployment.

(ii). From 2006 Q4 to 2007 Q2 there’s a decrease in unemployment.

(b). 2005 Q3 has a higher total unemployment than 2007 Q2. This id due the difference.

Causes of unemployment:

- Frictional unemployment – “between jobs…” e.g. Actors or musicians. This will be affected by: Level of transferable skills, geographical mobility, level of benefits, general state of the economy

- Structural unemployment – old industries close … their skills are obsolete- Technological unemployment – machines replace people- Seasonal and casual unemployment – unemployment occurs at certain times of the

year- Demand deficient unemployment – too little demand in the economy- Cyclical unemployment – caused by a recession in the economy

2 (a). For Kate Morris, this was seasonal unemployment due to her working in the hotel summer months where the hotels need more staff to counteract with more customers.

(b). For John Penny, this was structural unemployment due to the takeover of big retailers and online retailers taking that demand leaving him redundant.

(c). For Manus “O” Brien, this was clear structural unemployment because he last had a job 12 years ago and now his skills are obsolete but it could also be technological unemployment because he might have been building a part in his local factory.

(d). For Claire Livingstone, this was cyclical unemployment because at her current time, the housing market in her local area is depressed meaning that there’s little to no demand for what she was working for and hence no need for her and she got sacked. If it was more than just her local area such as many regional or national area in this situation, then there’s a demand deficit unemployment.

(e). For Gavin Linker, this was frictional unemployment bordering onto structural unemployment because between 1 to 2 years is borderline between the two. Gavin has the capacity of getting a similar job but he wants it in his local area.

3 (a). In this article, people who are unemployed had a generally a worse psychological health than people who are employed. In the article, they studied 6,000 employed and 6,000 unemployed and they have found out that the people unemployed are, “more likely to get depressed, less likely to mix with people at work and had little access to social support networks or to information about jobs.” This in simple words, the people are unemployed are less happy in general than people who are employed.

(b). This rise of costs isn’t just for the unemployed but for the society as a whole because as more people are getting unemployed AD as a whole decreases because they are forced to cut their spending due to the lack of money coming in to their products and this affects the suppliers by them not selling as well as they should do so they cut more jobs and this vicious cycle increases and therefore the price level increase.

Costs of unemployment

- Lost output- Deteriorating skills- Cost of benefits- Social problems & crime- Psychological problems

Benefits of some unemployment

- Keeps wages lower- Contributes to wider pay differentials (skilled workers want more money then

unskilled workers)- Ready pool of labour

How to reduce unemployment

Government policies to reduce unemployment depend upon the causes:

- Raise AD (by fiscal or monetary stimulus) (demand deficient)- Cheap housing (to tackle regional U)- Education and training (occupational immobility) (people who can’t work in any

other sector apart from their prior job)- Reform/ reduce government benefits- Supply side reforms (to improve competitiveness)

Inflation and Deflation

Inflation: A continuous rise in the price level (i.e: money loses its value)

Hyper-inflation: extreme inflation, money becomes worthless

Deflation: A fall in prices; firms may cut wages to cut costs.

Measuring Inflation

Retail Prices Index (RPI). The government measures rice changes every month for a typical “basket” of (weighted) goods bought by the average family. This gives an index number showing the average price rise across the economy.

The RPI is accurate for the average family… but less so for others…

In particular, it often underestimates the rising cost-of-living for pensioners – whose pensions are linked to the RPI.

Consumer Prices Index (CPI) is derived from the RPI, but excludes mortgage repayments & council tax. Used to set the target rate for the Monetary Policy Committee (2%).

1 (a). From mid-1990 to mid-1992, inflation was growing up to 2,500% inflation (hyper-inflation) in the Russian Federation. This severe inflation dropped to the nation’s average

inflation near end-1996 (over 6 years). After that, it only went up slightly in the year 1999 but apart from that, it remained stable.

(b). From 1991 to 1993 they saw hyper-inflation.

Causes of Inflation

Demand-pull: This is caused by “too much money chasing too few goods”.

- Wages rising higher than output- A significant fall in interest rates- Excessive government spending- Sharp drop in the savings ratio

Cost-push: In the 1970’s it was argued that rising costs caused inflation…

- Militant trade unions pushing for excessive wage claims…- Rising costs of imported raw materials, food… - A fall in exchange rate, raising import prices.

Balance of payments

Why trade?

- We cannot find/ make them here- Other countries make them cheaper- Other countries make them better

In the past we

- Imported lots of raw materials- Used them to make goods- Then exported these goods

1a. India, Russia and USA only export 10% of their total goods where as other countries like Malta and Holland export 80% and 55% respectively. This is partly due the size of their economies, Malta’s 80% could be less than 1% of USA exports. Furthermore, overall in those three countries, there are bigger firms which trade in hundreds of millions or billions in exports or imports and that much money could be particularly from Malta, there GDP. These countries are self-sufficient.

b. USA has a far superior influence to the UK economy than Malta does due to the fact that there’s more trade happening in USA than anywhere else in the world and also there GDP is far higher than in Malta meaning that the money flowing in and out of the country will not only be more likely it’ll come to UK’s pockets but more money than in Malta.

2a. Car making: Shared due to the many ways of building a car for the road and as well at different price points of a car. For some countries like Vietnam it’s cheaper building a car from yourself or what most people do instead which is to buy a motorbike than buy a foreign car due to import tax.

Shipbuilding: Used to be Western countries but now it’s predominantly third world countries because it costs far less nowadays to make the same material than Western countries due to many things which I won’t go into detail. Some argue that the quality isn’t good but I once again I won’t go into detail.

Steel: Almost identical to shipbuilding in terms of the way it’s now largely made in third world countries however, there’s a slightly higher percentage of steel being made in western countries I believe than shipbuilding. Although I could be wrong.

Cotton textiles: Third world countries because it’s very easy compared to the other products to make but it requires a higher amount of manual labour and that’s where the third world countries do.

Computer design: Will always be in Western countries or in countries like India where there’s a growing use of computers due to quaternary boom over there and in other countries.

Aircraft manufacture: USA and Europe with this between Boeing and Airbus for big planes and Cessna and other smaller companies with small aircraft. This is due to the well-established history of people in USA and Europe building planes for over a century now and for a big company to step in. They’ll have to pay hundreds of millions to even begin to compete with the oligopolies.

Nuclear engineering: All developed countries with the exception of Iran which is in a quite controversial state. This is due to the peace treaty with nuclear weapons with Russia and USA cutting back on nuclear weapons over the forthcoming years which is a good thing because those two countries hold the most amount of nuclear warheads.

Petrochemicals: Modern countries will because the companies are oligopolies meaning that it’ll take billions of pounds just to start a business and to keep up with the companies.

Railways: Shared because that’s the transport we are always growing in almost every country (nearly) regardless of the country’s GDP.

b. Structural unemployment because ship building, coal mining and jobs which were booming in the past now largely don’t exist in that country and the people who trained to do those jobs are now depending on their substitute which is generally far worse than what they trained for and to try and prevent them not working is to educate and teach how to do jobs in the modern world.

3a. 3400 - 3600 = -200 Deficit

b. 3000 - 2600 = 400 Surplus

c. 4500 - 4500 = 0 Balanced

d. Can’t do, haven’t received the statistics.

4. This restriction reduces Imports from the UK because they could only spend up to the maximum and presumably, some people were spending more than that and if there was a

similar amount of people going to France after this law, on average, people will spend less money. This affects the balance of invisibles. Also, you have to take into account that this was 1983 when the currency exchange for the sterling was very strong; much stronger than the euro so people from abroad were spending not that much in the UK but a lot for France and for other countries who have adopted the Euro.

We need to keep track of our spending & receipts:

Inflows – money entering the UK e.g.

Outflows – money leaving the UK

It’s split into:

- Current account – payment for goods & services- Capital account – flows of savings, investment, speculation & currency stabilisation

Visibles – trade in goods, raw materials, components etc. The difference between visible imports & exports is called the balance of trade

- Surplus (X>M)- Deficit (M>X)

Invisibles – trade in services

Gives the balance on the invisibles – surplus or deficit.

Interest, profits & dividends & transfers.

Balance of trade (100 billion pounds)

Balance of Invisibles 120 billion pounds

Balance of income & transfers (35 billion pounds)

Total: (15 billion pounds)

This shows a deficit of £15bn – sometimes called a “trade gap” …

A positive value is called a surplus.

Causes of changes in the Current Account:

- Export prices may change – e.g.: through improved technology, labour productivity (down): or taxes, inflation (up).

- Change in the exchange rate – e.g.: fall in value of sterling helps boost exports & cut imports.

- Boom/ recession in foreign economies (exports) or at home (imports)- Change in the quality of the products- Boom/ recession overseas changes repatriated profits, & transfers. (repatriated is

returning home e.g. Barclays owns an American bank, some of the money is transferred back to the UK).

Current Account Deficits

Persistent large current account deficits are bad for an economy. They must be financed by:

- Using our “savings” of gold & foreign currency- Borrowing from foreign lenders…

Continuous borrowing can lead to credit problems. Countries may be forced to reduce imports (e.g.: by reducing domestic aggregate demand), & try to export more.

Encourage exports – Devaluation

Exports can be encouraged by devaluing the currency:

£1 = $3 Cost of product in UK = £30,000 Price in USA = $90,000After devaluation

£1 = $2 Cost of product in UK = £30,000 Price in USA = $60,000Imports become correspondingly more expensive…

Problems with devaluation:

- Depends upon PED (Price Elasticity of Demand)- Imports become correspondingly more expensive … causing inflationary pressures.

Improve price competitiveness through improved productivity:

- Capital investment (through tax allowances; but how much? Will exporting firms take advantage?)

- Training (to whom? What skills? Can be costly)

Keep inflation low In recessions, UK firms may seek exports to maintain sales

15a. Economic growth has been a success through the 1990’s and 2000’s due to the only time economic growth was below 2% was between 1996 and 1999 which is over a decade very good. With its peak at 1995 and between 2004 and 2006 at 6%.

b. The large current account deficits could be bad depending on the reason it is down to. If its capital equipment then in the long term, it can easily remove its deficit as they’ll make more goods in the future. However, of its consumer goods than this could be a big problem.

Reducing Imports

- Devaluation (inflationary pressures)- Import taxes or quotas (not possible for EU imports; countries may retaliate)- Imports will fall during recession (will rise in a recovery)

Current Account Surpluses

Persistent surpluses boost economic growth. Maintaining a low exchange rate – makes exports cheap & imports dear. Surpluses can be invested to earn wealth in future; and cope with structural changes (e.g.: ageing population).

But persistent surpluses may bring problems:

- Rising valuation of the currency – exports become more expensive- Growing demand for exports may be inflationary if the economy is close to full

employment- May cause friction with countries with large deficits… who may erect trade barriers…

16a. Japan’s current balance between the late 1980’s to 200’s is at a surplus with a minimum of over 1% of Japan’s GDP at 1989 and 1995. USA is the complete opposite with every year in a budget deficit except briefly inn 1990 where it was balanced at 0%.

b. The benefits of Japan’s current account being consistently at a budget surplus is that it can pay off its debts or save it for the future problems e.g. ageing population. The disadvantages though could be that there will be less demand for their imports with other countries competing with each other and that demand will go to the substitutes.

Fiscal policy

- Tax: Raising taxes cuts consumption & vice versa (AD falls)- Government spending: Raising this increases aggregate demand & vice versa- Budget deficit: When government spending is greater than tax revenues, they

borrow this money and so to optimise this, the interest rates should be to the minimum. It may be used to stimulate the economy when unemployment is too high

- Budget Surplus: Is where the government will save money to do other stuff with it such as to pay off our national debt, it’s used to cool the economy when inflation is too high.

Expansionary fiscal policy

- B is past full employment meaning workers are paid overtime (1.5 to 2 times). This means inflation goes up meaning imports rise and export falls, this changes the balance of payments

- It could create higher economic growth and less unemployment but sacrifices inflation and balance of payments

Fiscal policy – supply side

- Lower rates of tax- Lower rates of benefits- Tax allowances lead to firms updating their capital equipment more regularly- New capital equipment – technology more advanced and productive

Budget deficits are financed by borrowing – this is the Public Sector Net Cash Requirement (PSNCR). This raises National Debt. The multiplier will amplify changes in spending, although

its effect is very limited where there are large leakages from the circular flow. In the past, governments have used fiscal policy to manage AD. These days, it is used more for supply side effect (e.g.: low taxes) and social benefits (health, education).

It can be used for demand management, to affect government targets (Keynesian view). Budget deficits…

- Can cause inflationary pressures…- Unemployment may fall- Economic growth accelerates (in short run)…- Can cause balance of payments deficits

Budget surpluses can have the opposite effect, extent depends on the size of deficit…