Menu costs costs of changing prices due to inflation

Shoe leather costs The term comes from the notion that people will
cope with inflation by keeping less cash on hand and making more
trips to the bank. In times of inflation, interest rates usually go up, so
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keeping as much money as possible in interest-bearing accounts can
Demand pull: increases in the price
be a good strategy.
level caused by increases in AD
Fiscal drag peoples income being dragged into higher tax brackets
AD= G + I + C + (X-M) as a result of tax brackets not being adjusted with inflation.
Loss of international competitiveness imports become relatively
Cost push: increases in the price level cheaper and exports become dearer
caused by increased factors of Monetary policy response increased nominal interest rates;
production. negative effect on output and investment

Causes of: Consequences:

RPI used for adjusting pensions

and other benefits
Measures of:
Inflation
Reduction:
CPI- measure of changes in the
price of a representative basket of
Benefits of:
consumer goods and services
Fiscal If govt believes AD is too high -> reduces public spending
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on merit goods or welfare payments. Or it can choose to raise direct
taxes. This takes money out of the circular flow of income therefore
decreased AD.
Business Growth - Controlled growth of Inflation, can become part of business
growth, simply because savings are often invested, because of the net loss if they are
Monetary higher interest rates to reduce spending therefore
kept in a Bank.
decreased AD
During times of controlled Inflation, people in the past tended to spend, as they
feared prices could rise, saving on buying now, rather then paying more later. Supply side increases in productivity, competition and innovation
causes decrease prices.
Falling Debt Values - Higher Inflation eats away at the real value of a currency.
This could mean that the actual value of debts decrease, benefiting indebted www.studyguide.pk - The #1 website for notes.
businesses and private individuals.

Higher Stock Values - Stocks bought at an earlier value, could rise in price and
sold off at a higher price bringing higher profitability. www.studyguide.pk
 Loss of income
Real wage unemployment Increased govt spending welfare benefits and job seekers allowance leading to increased in the budget deficit
Demand deficient Social costs - Rising unemployment is linked to social deprivation
unemployment Negative multiplier effects - One persons spending is anothers income so to lose well-paid jobs can lead to a drop in
Frictional unemployment demand for local services, downward pressure on house prices and second-round employment effects for businesses
Structural unemployment
supplying the factor or plant that closed down.
Claimant count Loss of national output - Unemployment involves a loss of potential national output (i.e. GDP operating well below
Causes of: potential) and is a waste of scarce resources. If some people choose to leave the labour market permanently because
ILO they have lost the motivation to search for work, this can have a negative effect on long run aggregate supply and
thereby damage the economys growth potential. Some economists call this the hysteresis effect. When
Labour force survey Measures of: unemployment is high there will be an increase in spare capacity - in other words the output gap will become
negative and this can have deflationary forces on prices, profits and output.
Time to explore job opportunities Benefits of:
Consequences:
Benefit from govt training and education,
could gain more rewarding jobs
Help to avoid inflation
Firms are able to expand
Unemployment
Reduction:

Demand side: ( Downloaded from www.studyguide.pk)

Supply side (www.studyguide.pk)
Expansionary Fiscal increase G (increase AD + positive multiplier effects), reduce T (increase Yd, therefore
increased AD + increased need for workers and increased retained profit) Education & training
Privatization breakup of monopolies
However,
to increase competition therefore more
Increase C may lead to increased leakages. Depend on level of C confidence available employment
Reduction in which tax and by how much? Tax cuts on lower levels of incomes increases AD due to De regulation aims to open up
higher MPC markets to greater competition and
Time lag increase market supply therefore more
If interest rates increase at the same time any increase in Yd is spent on MIR workers needed
Income tax reforms and incentive to
Monetary: Downloaded from www.studguide.pk work short term boost to demand,
and they improve incentives for people
MIR, cost of borrowing, savings
to work longer hours or take a new job
o Investment - funded from retained profits and not borrowed wanting to keep a higher percent of
However,
money therefore little impact upon I. Also Investment on their income.
appropriate projects www.studyguide.pk
o Size of reduction if firms think it will be short lived or small
they may not borrow.
 Stronger

Pound

Imports Desire to buy

imports Investment abroad
Cheaper
Interest rates
Exports
abroad hot Keep printing =
money flows loss in value
Dearer
What determines the
demand of the pound?

Exchange rate
Price of once currency in terms of another

-Exchange rates are determined by interaction of demand and supply

p
What determines the
demand of the pound?
Incomes at home =
Buying UK exports
decrease in value

These notes have been downloaded from

Foreign
Hot money flows www.studyguide.pk so please visit the visit the website for more
investment
notes and donate to keep us running.
paying UK
Rise in UK interest companies
rate = increased
demand
Incomes abroad =
increases value www.studyguide.pk
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Increases in AD if the economy is initially producing below full
capacity
Low interest rate
High wages
Did you know ?
Increased govt These notes were downloaded from:
spending
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Economic growth
Short run; increase in real GDP.

Long run; increase in productive capacity (maximum output the economy can
produce).
LRAS or potential growth can increase for the
following reasons

1. Increased Capital e.g. investment in new factories

or investment in infrastructure such as roads and
telephones.

www.studyguide.pk 2. Increase in working population

3. Increase in Labour productivity, through better

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4. Discovering new raw material

5. Technological improvements to improve the

productivity of Capital and labour
Protectionism represents any attempt by a government to
impose restrictions on trade in goods and services between
countries:
o Tariffs - import taxes.
o Quotas - quantitative limits on the level of imports
allowed.
o Voluntary Export Restraint Arrangements
where two countries make an agreement to limit the
volume of their exports to one another over an
agreed period of time.
o Embargoes - a total ban on imported goods.
o Subsidy paid by govt to help firms in producing
to compete with the international market
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Protectionism
Consequences:
Trade wars - There is the danger that one country imposing
import controls will lead to retaliatory action by another leading
to a decrease in the volume of world trade. Retaliatory actions
increase the costs of importing new technologies
Negative multiplier effects - If one country imposes trade
restrictions on another, the resultant decrease in total trade will
have a negative multiplier effect affecting many more countries
because exports are an injection of demand into the global circular
flow of income. The negative multiplier effects are more
pronounced when trade disputes boil over and lead to retaliation.
Loss of economic welfare: Tariffs create a deadweight loss of
consumer and producer surplus arising from a loss of allocative
efficiency. Welfare is reduced through higher prices and restricted
consumer choice.
Justification for protectionism:
Protect infant industry - The infant industry
argument suggests that an industry may be
developed under the umbrella of the governments
temporary protection. Such a policy must weigh
the future cost savings of an industry in which
dynamic economies of scale are present with the
current consumers foregone rents due to higher
domestic prices as well as higher imported prices of
similar product
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Nature of dumping - Dumping is a type
of predatory pricing behaviour and is also a form
of price discrimination. The concept is used most
frequently in the context of trade disputes between
nations, where businesses in one or more countries
may seek to produce evidence that manufacturers
in another country are exporting products at a
price below the true cost of production.
Externalities, Market Failure and Import Controls -
Protectionism can also be used to take account
of externalities and dealing with de-merit
goods. Goods such as alcohol, tobacco and
narcotic drugs have adverse social effects and are
termed de-merit goods. Protectionism can
safeguard society from the importation of these
goods, by imposing high tariff barriers or by
banning the importation of the good altogether.
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