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AS Economics

MacroEconomics
Revision Workshop

Student Name
Session 1
Dissecting the Recession
Question 1 In economics, investment is best defined as Your Actual
answer answer

A The flow of money into the stock of savings

B Spending on capital goods in the economy

C The profit kept back by firms to finance future


spending on new machinery and equipment
D The stock of economic resources such as factories
and machinery

Question 2 Which one of the following would NOT be Your Actual


regarded as a macroeconomic policy objective? answer answer

A Achieving a steady rate of economic growth

B Increasing total investment in the construction industry

C Avoiding a period of time when the general price level falls

D Reducing the employment consequences of the recession

Question 3 As a component of aggregate demand, Your Actual


consumption is best defined as answer answer

A Spending on all goods and services including imports

B Spending on all goods and services excluding exports

C Spending by households on goods and services

D Spending by households and government including exports

Question 4 Cyclical unemployment is most likely to be Your Actual


caused by answer answer

A Changes in the demand for labour at different times


of the year

B A recession in the country of a major export partner

C A rise in the number of people leaving university with


a degree
D The skills of the unemployed not matching those required
for the available jobs

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Understanding the components of aggregate demand (AD)

Write down the formula for calculating aggregate demand

Focus on consumer spending (C)


1 Consumption is the biggest component of Aggregate Demand
2 It drives production and profits in the short term
3 Consumer spending rarely falls but this recession has been different
4 AS requires you to understand what drives consumption and also evaluate its
importance to other macroeconomic objectives

Consumer spending in the UK fell by 3% in 2009 – the deepest fall


for over twenty years – identify four factors that might explain this fall

1
2
3
4
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The rise of household saving
One key change in the UK economy has been a sharp rise in the household saving ratio
– rising from 0% of disposable income to over 8% in less than two years – what has
caused this and what are the benefits and risks for the UK economy?

Benefits from a higher Risks from a rise in saving


savings ratio

1 1

2 2

3 3

4 4

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Evaluation – the significance of consumption for other
macroeconomic objectives

In 2009 UK household spending fell sharply –


explain how this might affect

The government budget deficit

The balance of trade in goods and services

Business investment spending

Inflationary pressures

Unemployment

Consumption and AD-AS analysis

Price Level

LRAS

AD

Real Output

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Business investment spending (I)

Identify four determinants of business capital investment spending

Evaluation: Why is the 15% fall in investment during the


recession significant?
1

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Dissecting the causes and consequences of the recession

In this section we look at causation and consequence –


How bad has the recession been?
What have been the major causes and effects?
Are there advantages from a recession?

Recessions have many explanations… can you think of five relevant


causes of the UK downturn from 2008 – 2009?
1

Key evaluation point: A cycle in one country can affect economic activity in others – the
UK economy is vulnerable to external shocks affecting aggregate demand and aggregate supply

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Consequences of the recession
Price Level

AD1

AD2 LRAS

SRAS

Y2 Y1 National Output

Summary notes on how the UK recession has affected:

1 Business profits

2 Labour productivity

3 Unemployment

4 The level of spare capacity (output gap)

5 The national debt

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Possible long term effects from the recession
This links in with session 2 on the supply-side of the economy.

National A deep recession may cause damage to an


Output economy’s potential growth rate
Some of the lost output may be unrecoverable
and the trend growth rate in a recovery might
be slower than in the past

Trend

Time

Multiplier and accelerator effects


You need to have a basic understanding of the multiplier effect and the accelerator process.

The Multiplier Effect

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Describing the Accelerator Process

Question 5 Which one of the following is most likely to occur Your Actual
in the boom phase of an economic cycle? answer answer

A Rising national income, falling unemployment & a negative


output gap

B Rising imports, rising profits and a positive output gap

C Rising consumption and investment and a negative


output gap
D Excess demand, falling employment and a positive
output gap

Question 6 The ‘multiplier’ usually refers to the final effect Your Actual
of a change in the level of? answer answer

A Aggregate demand upon imports

B National income upon aggregate demand

C Saving upon investment

D Exports upon national income

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Session 2 Supply-side policies
and the long-run performance of an economy
Question 1 The underlying long-run trend rate of economic Your Actual
growth can be defined as the? answer answer

A Rate of economic growth that can be maintained


in the long run
B Highest rate of growth achieved in the long run by
an economy

C Average rate of economic growth in a boom period

D Rate of growth achieved for a period of more than two


quarters

Question 2 Which one of the following is most likely to


achieve an increase in an economy’s underlying Your Actual
answer answer
trend rate of growth?
A A rise in inflation

B A rise in labour productivity

C A rise in labour productivity

D A rise in household disposable income

Question 3 A supply-side policy can be used to increase Your Actual


answer answer

A Interest rates

B Government spending

C Tax rates

D The mobility of labour

Question 2 All other things being equal, which one of the


following is most likely to cause a simultaneous Your Actual
shift to the right in both an economy’s short-run answer answer
and long-run aggregate supply curves?
A An increase in the rate of interest

B An increase in the number of immigrant entering the country

C A increase in the rate of Value Added Tax (VAT)

D An increase in the national minimum wage rate

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Supply-side policies in action

We will go through some examples of supply-side policies from the UK and other countries –
this is an area where good examples can really help your answer.

Policies to stimulate Policies to improve


enterprise productivity

Policies to promote Policies to improve mobility


innovation

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Why are successful supply-side policies important?
All governments give emphasis to improving the supply-side – why is this? In this section
we link the effectiveness of supply-side policies to a range of economic policy objectives.

Notes on the importance of supply-side policies in these policy areas

1 Unemployment

2 The Balance of Payments

3 Underlying economic growth rate

4 Controlling inflation

5 Improving the environment

6 Raising living standards and reducing poverty

Supply-side policies and the trend growth rate – a good diagram to use

National
Output

Trend

Time

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Supply-side policies - using AD/AS diagrams to show a rise
in productive potential

Price Level

LRAS

National Output Yf1

Evaluation points on supply-side policies

Many of these policies


have long time lags!

Level of demand is
important in making
investment and innovation
viable

Some risks of over-


investment – leaving
excess capacity (examples
of countries here?

Most supply-side
improvements come from
the private sector

Sustainability issues if
policies raise a country’s
long term growth rate

When writing about supply-side policies in the UK remember to focus on the global nature
of the economy and the importance of the economy remaining competitive in domestic and
overseas markets. The challenges from emerging market countries are especially important.

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Focus on two supply-side indicators

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Question 5 The diagram below shows two long run aggregate supply curves for at
equilibrium at Y1. In order to move the economy to Y2, a government might

Price Level LRAS1 LRAS2

Output
0 Y1 Y2

A Try to lower the value of the exchange rate

B Increase the level of taxation on business

C Reduce expenditure on the national health service

D Reduce the level of tax on profits that flow from new patents

Question 5 The diagram below the AD and SRAS curves for an economy that is
initially in equilibrium at W. Following a 20% rise in imported raw material
prices and a fall in export sales due to a recession in a major trading-
partner economy, equilibrium is likely to

Price Level
SRAS2
X
Y SRAS1
W
Z

AD1
AD2
Output

A Stay at W

B Move to Z

C Move to Y

D Move to X

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Session 3 UK Economy in Focus –
Issues facing the UK economy in 2010 and beyond
In this special macroeconomics presentation we will consider key recent
developments in the UK economy and try to connect as many different parts
of the AS Unit 2 course together as we can. How strong is the economic
recovery likely to be? What are the main risks for the UK economy in the
months and years ahead? Are there reasons to be cheerful?
During this presentation jot down arguments and ideas that you find most relevant – and use
this as a great chance to show the examiner that you are right up to date with important
developments in the UK and world economy! This will boost your evaluation marks!

Issues Facing the UK Economy

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Session 3 Study Notes

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Session 4
Managing the Economy
We will look at lessons from the credit crunch and recession and
revise the ways in which monetary and fiscal policies have been
used both in the UK and overseas to stabilize the economy.
A quick reminder on the two main policy options for individual governments / central banks

Monetary Policy
• Changes in policy interest rates
• Quantitative easing (QE)
• Changes in the exchange rate
Fiscal Policy
• Automatic stabilisers
• Changes in government spending
• Changes to direct and indirect taxes
• Changes to the level of government borrowing

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Check your understanding of monetary policy

Question 1 Which one of the following statements about Your Actual


monetary policy is correct? answer answer

A A cut in interest rates always increases inflation

B While reducing excess demand, higher interest rates may


cause cost-push inflation

C Interest rate changes have no effect on aggregate supply

D An increase in interest rates will increase business


investment

Question 2 All other things being equal, a rise in the value


of the pound on the foreign exchange markets Your Actual
answer answer
is most likely to increase?

A The rate of inflation in the UK

B The level of interest rates in the UK

C The UK’s current account deficit on the balance of payments

D The volume of UK goods and services exported overseas

Question 3 Expansionary monetary policy is most likely to Your Actual


answer answer

A Shift the long run aggregate supply curve to the left

B Result from a reduction in taxation

C Cause a trade surplus on the balance of payments

D Reduce the amount of spare capacity in the economy

Question 4 In March 2009 the Bank of England continued


the trend of falling interest rates by cutting the Your Actual
base rate to 0.5%. One justification for this answer answer
might have been the MPC’s concern over
A Changes in the demand for labour at different times
of the year

B A recession in the country of a major export partner

C A rise in the number of people leaving university with


a degree
D The skills of the unemployed not matching those required
for the available jobs

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Monetary Policy
Monetary policy involves changes in
• Policy interest rates (and other interest rates in the economy)
• The exchange rate
• The availability of credit
To influence
• The level and growth of aggregate demand and output
• Control inflationary and deflationary pressures
• Meet an inflation target and achieve price stability

Recent changes in UK interest rates

Your notes on the recent changes in UK interest rates

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Why has the Bank of England cut interest rates to such low levels?

1 Response to the credit crunch

2 Risks of deflation

3 To prevent a depression

4 To stabilize confidence and demand

A Quick Return to the Credit Crunch

Freezing of Higher
credit supply Interest rates

Increased Fall in consumer


risk of default borrowing and
on loans house prices

Hits
personal
sector wealth

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How rates affect the economy – analysis and evaluation
A change in interest rates affects AD, output and inflationary pressure in several ways.

Consider the decision to cut interest Your notes


rates below 1%

Consumer
and Business
Confidence

Effects on
the housing
market

The incentive
to save

The cost of
borrowing
and the cost
of servicing
existing debts

The value of
the exchange
rate

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Evaluation points on interest rates and the economy
Low interest elasticity of demand especially in a recession

Fixed interest rates for many borrowers

Impact on savers especially older people

Time lags for interest rates to work

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Quantitative Easing
The Bank of England introduced a policy of quantitative easing in March 2009. The Bank of
England has bought up to £200 billion of assets - mainly government bonds financed by the
issuance of new central bank reserves.

Bank of Buys bonds - This lowers the


England creates drives bond yield (interest
new money prices higher rate) on bonds

Commercial should Boosts demand


banks now have stimulate more in economy
more deposits lending

Exchange rates and economic performance


It is important to realize that movements in the exchange rate – the purchasing power of one
currency against another – form part of monetary policy. We have seen big changes in the
value of the pound (sterling) in currency markets over the last two to three years – here is
sterling against the US dollar.

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Economic benefits and costs from a lower exchange rate
Consider an exchange rate depreciation for the pound against the Euro.

Advantages of a lower £ against the Euro Disadvantages of a cheaper pound v the Euro
Overseas demand for UK exports Costs of imported components & raw materials

Expenditure-switching away from imports Costs of imported technology products

Value of overseas investment and subsidies Inflationary dangers

Multiplier and accelerator effects Risks for foreign investors

Analysing the possible effects using an AD/AS diagram


Price Level

LRAS

National Output Yf1

Has the lower pound helped? Some evaluation points

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Fiscal policy – aggregate demand and supply effects
Our focus here is mainly on how fiscal policy has been used to manage the economy during the
financial crisis and recession. But it is important to understand that fiscal policy decisions affect
both aggregate demand and aggregate supply. Indeed many of the fiscal stimulus policies of the
last few years might also have significant effects on aggregate supply.

Fiscal stimulus policies in the UK during the recession

Taxes Subsidies

Budget Govt
deficit spending

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Economics of the budget deficit
Fiscal policy has been used to actively manage demand in the UK during the recession.
A rising budget deficit is an expansionary fiscal policy. But borrowing money on such a huge
scale invites an evaluation about the benefits and costs of running a large budget deficit.

Building a good evaluation discussion


Justifying higher government borrowing Economic risks of a high budget deficit

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Test your understanding of fiscal policy

Question 1 A budget deficit Your Actual


answer answer

A Means that the value of imports are greater than exports

B Will lead to an increase in the National Debt

C Will help to reduce aggregate demand

D Will lead to a reduction in interest rates

Question 2 Which one of the following is an example of a


contractionary fiscal policy designed to reduce Your Actual
answer answer
inflationary pressure?

A An increase in the government budget surplus

B A reduction in the exchange rate

C Higher interest rates

D An reduction in the rate of tax on business profits

Question 3 According to Keynesian economists, for which


one of the following types of unemployment Your Actual
might an increased budget deficit be the most answer answer
appropriate policy?

A Frictional

B Structural

C Cyclical

D Technological

Question 4 An economy finds itself in a position where


actual GDP is below Trend GDP and is predicted Your Actual
to fall further. What combination of policies is it answer answer
most likely to implement in this situation

A Higher taxes with lower interest rates

B Higher taxes with higher interest rates

C Lower taxes with lower interest rates

D Lower taxes with higher interest rates

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Session 5
Techniques for scoring high marks on data
questions
Data Description Tips
Many early questions on the paper ask you to describe data shown in a chart or table.
Question commands might include:
• Using the data identify two components from the table that have led to an
improvement in the current account of the UK balance of payments
• Using the extract, identify two main features of the annual growth of UK labour
productivity for the period from 2002 to 2007
• Using the extract, identify two points of comparison between the changes in the
bank interest rate and the consumer price inflation rate between 2004 and 2007

Using Extract 1, identify two points of comparison between the changes


in UK real GDP and UK unemployment between the years 2004 and 2009

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Tips for scoring high marks on evaluation questions
Evaluation questions carry the highest marks and the quality of you answer will make a huge
difference to your final grade. We will offer our suggestions for doing well on evaluation.
Some recent evaluation questions on Unit 2 papers:
• Using the data and your own knowledge, assess the importance of higher labour
productivity in bringing about improvements in UK macroeconomic performances
• Assess the view that a fall in the exchange rate of the pound will help improve the
performance of the UK economy
• Assess the view that inflation is always caused by an increase in aggregate demand
• Assess the view that rising consumer spending is always good for the UK economy
• Evaluate alternative measures that can be used to reduce unemploymenty

Evaluate alternative measures


that can be used to reduce a
trade deficit

32 AS ECONOMICS Revision Workshop April 2010


Some good evaluation phrases

In the Exam Room

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UK Economy at a Glance
Recession Recovery
2009 2010 Comment

Consumer -3.1 0.4 Modest rebound in spending - tax rises, high


spending unemployment and continued need to repay
debt
Government 2.0 1.7 Squeeze on real government spending likely
consumption to be delayed until 2011 when the Politics is
settled
Investment -14.4 -0.5 Deep cut in capital spending last year - less
severe in 2010 but weak demand holds back
investment
Stockbuilding -1.2 1.0 Many firms cut back on stocks/ production in
(% GDP) 2009, signs of a recovery in inventories in
2010
Domestic demand -5.1 1.6 Overall C+I+G was strongly negative in 2009
(a largely home-made recession?) Weak again
in 2010
Exports -10.9 4.8 Exports hit by sharp fall in global output/trade
in 2009. More positive in 2010 - weak sterling
helping?
Imports -12.1 3.0 Imports slumped as UK went into downturn
(UK has high income elasticity of demand for
imports)
GDP -4.9 2.0 Deep recession (-6.2% over course of
recession) - scraping towards 2% growth in
2010 (the new trend?)

Manufacturing output -10.4 3.2 Collapse in industrial output in 2009 but more
signs as industry benefits from weak pound
Unemployment LFS) 7.6 7.7 Unemployment to stay lower than in the
measure (%) last recession - fewer hours and wage cuts
have helped
Unemployment CC 4.9 6.1 Claimant count also likely to peak below
measure (%) 2 million - but long term unemployment is a
worry
Labour force (million) 31.4 31.2 Small shrinkage in size of labour force - partly
reverse migration and discouraged worker
effect
Average earnings -0.1 3.4 Negative earnings growth for millions in
(inc. Bonuses 2009 - pay cuts and pay freezes (but CEO
pay remained strong)
RPI Inflation -0.5 3.8 Some deflation in 2009 (mainly due to big
cuts in mortgage interest rates) - RPI spikes
higher in 2010

34 AS ECONOMICS Revision Workshop April 2010


CPI Inflation 2.2 2.8 CPI has remained above target during the
recession - policy makers happy to ignore this
for now

Real wages -1.0 -2.6 Important data - in this recession, real


(deflated by CPI) wages have fallen for a significant number
(wage flexibility?)
Productivity -3.2 3.0 Drop in productivity in 2009 explained
(output per worker) by weak output - but also long term factors
limiting efficiency
Unit labour costs 4.3 -3.4 2010 will see a fall in UK unit labour costs -
(ULCs) an improvement in competitiveness which will
help

BoP Current Account -1.1 -0.7 UK heading back to balance /


(% GDP equilibrium on the balance of payments, not
really a policy issue
Budget Balance -11.0 -10.1 This is the big macro policy issue - how much
(% GDP) borrowing can be sustained? When to
squeeze policy?
Government debt 68.6 80.3 Sharp rise in government debt
(% of GDP) (although lower than many EU countries) and
much debt is long-dated

US Dollar /Sterling $1.57 $1.61 Relative exchange rate stability against the
dollar? Hard to forecast - many UK imports
priced in Ss
Sterling / Euro Euro 1.11 Euro 1.09 Euro set to gradually strengthen against
sterling despite woes of the PIGS
Base (policy) 0.5 0.5 Policy interest rates set to remain
interest rate (%) below 1% for at least the rest of the year -
MPC in wait and see mode
10-year government 4.1 3.4 Where next for bond yields? Much depends
bond yield (%) on election result and credibility of new govt
fiscal plans

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AS MACRO Key Term Glossary
Accelerator effect Where planned capital investment is linked positively to the past
and expected growth of consumer demand.
Animal spirits The state of confidence or pessimism held by consumers and
businesses.
Appreciation A rise in the market value of one exchange rate against another
Automatic stabilisers Automatic fiscal changes arising automatically as the economy moves
through different stages of the business cycle - for example a fall tax
that the government takes out of the circular flow in a recession.
Bank run When a substantial number of depositors suspect that a bank may
go bankrupt and withdraw their deposits. Bank runs are rare but one
happened with the Northern Rock in the autumn of 2007.
Bond Both companies and governments can issue bonds when they need to
borrow money. The issue of new government debt is done by the central
bank and involves selling debt to capital markets.
Budget deficit Occurs when government spending is greater than tax revenues. The
UK budget deficit in 2009-10 is forecast to be more than 12% of GDP.
Business confidence Expectations about the future of the economy – vital in business
decisions about how much to spend on new capital goods.
Capacity utilisation Measures how much of the productive potential of the economy is
being used. Utilisation falls during a recession.
Capital stock The value of the total stock of capital inputs in the economy
Capital-labour Replacing workers with machines in a bid to increase productivity.
substitution This can lead to structural unemployment.
Catch-up effect This occurs when countries that start off poor tend to grow more rapidly
than countries that start off rich. The result is some convergence in the
standard of living as measured by per capita GDP.
Claimant Count The number of people claiming unemployment-related benefits. Since
October 1996 this has been defined as the number of people claiming
Jobseeker's Allowance.
Classical LRAS The classical LRAS curve is drawn as vertical because classical
economists argue that a country’s productive capacity is determined by
factors other than price and demand such as investment and innovation.
Comparative advantage Comparative advantage refers to the relative advantage that one country
or producer has over another. Countries can benefit from specializing in
and exporting the product(s) for which it has the lowest opportunity cost
of supply.
Corporation Tax A tax on the profits made by companies.
Constant prices Constant prices tells us that the data has been inflation adjusted.
Consumer confidence Expectations about the future including interest rates, incomes and jobs.
Consumer durables Products such as washing machines that are not used up immediately
when consumed and which provide a flow of services over time.
Credit crunch Situation where banks across the economy reduce lending to each
other due to falling confidence that loans will be repaid. This restricts
the flow of money around the economy and can result in less credit
being available for consumers and businesses, resulting in an increase
in the cost of obtaining credit.
Current account of the The overall balance of credits minus debits for trade in goods, trade
Balance of Payments in services, investment income and transfers.

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De-industrialization A decline in the share of national income from manufacturing industries.
Deflation A persistent fall in the general price level of goods and services.
Depreciation A fall in the market value of one exchange rate against another.
Depression Used to describe a severe recession which may become a prolonged
downturn in the economy and where GDP falls by at least 10 per cent.
Deregulation Reducing barriers to entry in order to make a market more competitive.
Discouraged workers People often out of work for a long time who give up on job search.
Discretionary fiscal Deliberate attempts to affect aggregate demand using changes in
policy government spending, direct and indirect taxation and borrowing.
Discretionary income Disposable income adjusted for spending on essential bills such as fuel.
Dumping When a producer in one country exports a product to another country at
a price which is either below the price it charges in its home market or is
below its costs of production.
Ecological debt Ecological debt is the concept that people’s demands have exceeded
the Earth’s ability to cope with the rising consumption of its resources.
Economic cycle Variations in the annual rate of growth of an economy over time.
Economic shocks Unpredictable events such as volatile prices for oil, gas and foodstuffs.
Economic stability When the main indicators such as growth, prices and unemployment
do not change much from one year to another.
Expectations How we expect the future to unfold – this can have powerful effects on
the spending decisions of households, businesses and the government.
Fine-tuning Changes in monetary policy or fiscal policy designed to gradually
manage the level of aggregate demand and prices.
Forecast A prediction made about the likely future performance of an economy.
Free trade When trade between nations is allowed to occur without any form of
import restriction.
Full capacity output A level of national output where all available factor inputs are fully
employed – this is a factor influencing the underlying growth rate.
Full employment When there enough job vacancies for all the unemployed to take work.
G7 A group of seven major industrialized countries: Canada, France,
Germany, Italy, Japan, the UK and the USA.
G20 A group of finance ministers and central bank governors from 20
economies, the G20 is a forum for cooperation on key issues.
GDP The monetary value of the output of goods and services produced
inside a country – regardless of ownership.
Gini Coefficient The Gini coefficient is a measure of the overall extent to which groups
of households, from the bottom of the income distribution upwards,
receive less than an equal share of income.
Globalisation The deepening of relationships between countries of the world reflected
in an increasing level of overseas trade and investment.
GNI Gross National Income – income generated from the resources owned
by inhabitants and businesses of a given country.
Golden Rule A rule introduced by the Labour government which says that borrowing
on state provided goods and services should be zero over the course
of one economic cycle. Borrowing is allowed when it finances capital
investment.
Hard landing A full-scale recession shown by a decline in real national output.

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Hot Money Money that flows freely and quickly around the world economy looking
to earn the best available rate of return. It might be invested in any asset
whose value is expected to rise (e.g. property or shares) or simply be
placed in an account offering the best real rate of interest.
Household wealth The value of assets owned by households – including property, shares,
savings and pension fund assets.
Immobility of labour Barriers to the movement of people between areas and between jobs.
Income elasticity Responsiveness of demand to a change in the real income of consumers.
of demand
Inflation target The Government sets the Bank of England a CPI inflation target, which
is currently 2 per cent. When inflation rises or falls more than 1% above
or below the target, the Governor of the Bank of England must write an
open letter to the Chancellor of the Exchequer to explain why.
Inflationary pressures Occurrences likely to lead to price rises. These can come from both the
demand and the supply-side.
Innovation Changes to products or production processes – innovation is important
in delivering improvements in dynamic efficiency.
Interest elasticity The responsiveness of demand to a change in interest rates. This is
of demand relevant in discussing the effects of changes in monetary policy.
International Monetary The International Monetary Fund (IMF) is an organisation of 186
Fund (IMF) countries, promoting global monetary cooperation, financial stability,
international trade, employment and sustainable economic growth.
It has provided help for several nations in the wake of the 2007-09
financial crises.
Inventories These consist of materials and supplies which are stored for use in
production, work-in progress, finished goods and goods for re-sale.
Investment Spending on capital goods including plant & machinery and infrastructure.
Investment income Interest, profits and dividends from assets owned and located overseas.
J Curve Effect The effect of currency depreciation on the trade deficit depends on
price elasticity of demand for exports and imports. In the short term,
demand is often inelastic and the J Curve effect says a trade deficit can
actually worsen after depreciation, but get better in the medium term.
Job search The process by which workers find appropriate jobs given their tastes
and skills.
Keynesian Unemployment caused by a lack of aggregate demand in the economy.
unemployment
Keynesian economics The economics of John Maynard Keynes. The belief that the state can
directly stimulate demand in a stagnating economy. For instance, by
borrowing money to spend on public works projects like roads, schools
and hospitals.
Labour shedding Cut backs in employment often seen in a slowdown or a recession.
Labour shortages When businesses find it difficult to recruit the workers they need.
Labour supply The number of people able, available and willing to work at prevailing
wage rates.
Lagging indicators Indicators which tend to follow economic cycles e.g. unemployment.
Leading indicators Indicators which predict future economic trends e.g. consumer
confidence.
Leveraging The use of borrowed funds to increase your capacity to spend or invest.

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LIBOR Libor stands for the London Interbank Offered Rate and is used by
banks world-wide to determine the rate at which they lend to each other
- whether that’s receiving or giving loans (including 24 hour - 5 year
loans). Libor rates are set daily and released at the same time everyday -
11am London time.
Life-cycle model A theory that says that savings rates depend on how old someone is.
Liquidity Liquidity refers to the ease with which something can be converted to
cash with little or no loss of value.
Macroeconomic The overall performance of an economy in terms of output, prices, jobs,
performance global trade and living standards.
Marginal propensity The proportion of any change in income that is spent rather than saved.
to consume
Marginal propensity The change in total saving as a result of a change in income.
to save
Marginal rate of tax The rate of tax on the next unit (£) of income earned.
Misery index A measure of welfare calculated by adding together the unemployment
rate and the rate of inflation.
Monetary Policy The MPC is a Bank of England committee of nine people which meets
Committee every month to set interest rates.
Money supply The entire quantity of a country's commercial bills, coins, loans, credit,
and other liquid instruments in the economy.
Multiplier effect If there is an initial injection (e.g. a rise in exports) into the economy
then the final increase in AD and Real GDP will be greater.
National debt The total amount of debt that the government owes the private sector
Nationalisation The act of bringing a privately owned asset, such as a company or
property, under state control.
Negative equity Negative equity occurs when the value of an asset falls below the
outstanding debt left to pay on that asset. Term is most commonly used
in connection with property prices and describes a situation where the
market value of a house is less than the existing mortgage debt.
Net investment Gross investment minus an estimate for capital depreciation
Net inward migration When the number of migrants coming into a country is greater than
those leaving in a given time period.
Net Trade The balance between the value of exports and imports. E.g. in 2009
the UK ran a trade deficit in goods and services of £40bn.
Nominal GDP This is the monetary value of all goods and services produced in the
economy expressed at current prices.
Non-inflationary growth Sustained growth of real national output whilst maintaining price stability
Output gap The difference between actual and potential national output. A negative
output gap after a recession implies that an economy has a large margin
of spare productive capacity.
Overseas assets Assets such as businesses, shares, property which are owned in overseas
countries and which might generate a flow of investment income which
is a credit item on the current account of the balance of payments.
Peak The high point of the economic cycle beyond which a recession starts.
Per capita incomes Income per head of the population – a measure of average living standards
Phillips Curve A statistical relationship between unemployment and inflation.
Policy asymmetry When a given change in interest rates affects different groups or
different countries to a lesser or greater degree.

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Precautionary saving Saving because of fears of a loss of real income or employment.
Price stability Price stability occurs when there is low inflation and the price changes
that do occur have little impact on day-to-day decisions of people.
Productive potential The productive capacity of the economy – boosted by high quality
investment.
Productivity A measure of efficiency e.g. measured by output per person employed
or output per person-hour.
Propensity to import The proportion of any change in income that is spent on overseas
products.
Propensity to save The proportion of any change in income that is saved rather than spent.
Protectionism Restricting trade through tariffs and other forms of import controls.
Quantitative easing Central banks flood the economy with money by printing new notes,
in order to increase the supply of money. The idea is to add more money
into the system to avert deflation and encourage banks/people to
borrow and spend.
Quota A quota imposes a physical limit on the quantity of a good that can
be imported into a country in a given period of time.
Real disposable Income after taxes and benefits, adjusted for the effects of inflation.
income
Real income Nominal income adjusted for the effects of price changes (inflation)
and expressed at constant prices.
Real interest rate The nominal rate of interest adjusted for inflation.
Real wage The nominal wage adjusted for the effects of inflation.
Recession A period of at least six months when an economy suffers a fall in output.
Redundancy Making someone redundant is to end their employment due to a lack of
work available for them.
Remittances Sending of money to people in another country.
Repo Rate (policy rate) The official 'base' rate of interest that is set by the Monetary Policy
Committee and which, when changed, sends a signal to the rest of the
financial markets about a desired change in the direction of other
borrowing and savings interest rates. Repo is the rate of interest at
which the Bank of England is prepared to lend to banks.
Retail Price Index (RPI) The RPI is broadly similar to the CPI but includes mortgage repayments
and some taxes, and excludes the top 4 per cent of earners. It is used to
calculate increases in wages, state benefits and pensions.
Risk averse Exhibiting a dislike of uncertainty, often seen in a recession.
Saving ratio The percentage of disposable income that is saved rather than spent.
Slowdown A fall in the rate of growth of an economy but not a full-scale recession.
Slump A sustained decrease in real GDP and a persistent rise in unemployment.
Soft landing A slowdown in economic activity but which does not result in a recession.
Spare capacity When a business is not making full use of its available capacity – there
are spare factors of production including land, labour and capital. When
an economy has plenty of spare capacity, short run aggregate supply
tends to be elastic.
Stagflation A combination of slow economic growth and rising inflation, can lead
to stagflation. The most notable recent period of stagflation occurred
during the 1970s, when world oil prices rose dramatically, and UK
inflation rose at one point to nearly 30 per cent.

40 AS ECONOMICS Revision Workshop April 2010


Sterling exchange The external value of sterling calculated using a weighted index of a
rate index basket of currencies – the weightings are based on the pattern of trade
between the UK and other countries.
Sustainable growth Growth which meets the needs of the present without compromising
the ability of future generations to meet their own needs. Economic
growth that can continue over the long-term without damage to the
environment, or the exhaustion of non-renewable resources.
Target A target is an objective of government policy e.g. low inflation
Tariff A tax on imported products which may be ad valorem (%) or a specific
tax (a set amount per unit imported).
Tight labour market When demand for labour is high and there are shortages of labour.
Businesses may have to offer higher wages to attract and keep the
workers they need.
Time lags The time it takes for one change e.g. a change in interest rates to affect
other variables e.g. consumer confidence and spending.
Toxic debt Loans that may not be repaid. They are especially scary because of the
risk that one toxic debt may poison other loans that were previously OK.
For example, if one home loan on one street goes bad, it might make
people think that all the loans on the street will go bad.
Trade deficit A trade deficit occurs when a country imports a greater value of goods
and services than it exports.
Trade-off A trade-off implies that choices have to be made between different
objectives of economic policy.
Tragedy of the A conflict over finite resources between individual interests and the
Commons common good which can lead to irreversible damage to the stock of
natural resources available to current and future generations.
Transmission How a change in interest rates affects the various sectors of the economy.
mechanism
Trend growth The long run average growth rate – mainly determined by changes in
the stock of available factor inputs and also improvements in productivity.
Trough The low point of the economic cycle beyond which a recovery starts.
Under-employment When people want to work full time but find that they can only get
part-time work – the result is a loss of hours that the economy can use.
Unemployment trap Disincentive effect if people are better off on benefits than working.
Unit wage costs Labour costs per unit of output.
Unsecured credit Credit not secured by another asset – i.e. money borrowed on credit
cards.
Wage price spiral A situation where workers bid for higher wages because they have seen
their real income eroded by rising prices. This can lead to a further burst
of cost-push inflation in an economy.
Wealth effect The supposed link between changes in wealth and household spending.
World Bank Owned by 186 member countries, the World Bank is a source of
financial and technical assistance to developing countries. It can
provide loans and grants for a wide array of purposes that include
investments in education, health, public administration, infrastructure,
financial and private sector development, agriculture and environmental
and natural resource management.
World Trade The WTO oversees trade agreements, negotiations and disputes
Organisation between member countries.

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Notes
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