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- Trade in Goods

- Trade in Services Measured

- Income
- Current Transfers - Claimant Count (job
- Balance of payments Balance of seekers allowance)
on Current Account payments - ILO = International
- Capital Transfers Labour Force Survey
(people available for
- Financial Account
Unemployment work)

Environment Causes
- Frictional Unemployment
Measures of - Demand Deficient
Taxation Non – Economic - Technological Unemployment
- Seasonal Unemployment
Economic Performance - Real wage / Classical
Measures - Structural Unemployment
Quality of

Economic Growth

Measured - Potential Growth

Measured - Actual Growth
- By GDP
- CPI (Expenditure and - Nominal Growth
- Real Growth
food survey, Price survey)
Terms GDP is the sum of all goods /
Causes of Growth - Potential Growth = an increase in the services produced in a country in 1
- Short Term = Increase in AD productive capacity of a country. year
- Increase in any of the components - Actual Growth = an increase in real Also sum of incomes and
- AD = C+I+G+(X-M) income or growth domestic product. % increase expenditure.
in output.
- AD can increase for the following reasons.
- a) Lower interest rates – this reduces the cost of borrowing How GDP is measured:
and so encourages spending and investment
b) Increased wages. This increases disposable income and - Government measures all 3
encourages consumer spending - All should amount to the same figure
c) Increased Govt spending. G is a component of AD (1.4 trillion)
d) Cut in Income tax. This rises consumer confidence, - However errors and omissions occur.
more disposable income.
Economic - During boom – GDP rises very fast
- Long Term = Increase in AS - Recessions = falls for at least 2
- Increase for the following reasons Growth consecutive quarters.
- 1. Increased Capital e.g. investment in new
factories or investment in infrastructure
Benefits of Growth
- 2. Increase in working population - Employees= Incomes rise, standard of living
- 3. Increase in Labour productivity, through rises. Real growth = real income rises. Increase in
better education and training growth can mean wealth in assets (housing,
- 4. Discovering new raw material / lower costs
shares) increases.
- 5. Technological improvements to improve the
productivity of Capital and labour - Firms = forms make a profit as selling more goods.
- 6. Deregulation As revenue rises firms can take on more workers
and invest more.
Costs of Growth
- Government= higher tax revenue with no tax
- Income inequality = unskilled people are less likely to benefit from increased
raise. Fewer unemployment benefits. Good fiscal
income. 2 speed world.
- Type of production changes= consumer to capital goods leads to short term Constraints on Growth
unemployment for people with no flexibility. - Government Instability = Economy cannot attract
- Environmental Problems = depletion of non renewable resources, more external inward investment, TNCs.
costs (CO2). However governments have more money so can clean up. - The country has a fiscal deficit = little power, war,
- Bottle necks = when there is little spare capacity factors of production rise in price. famine.
(Labour, fuel). - Labour market problems = shortage of skilled labour
- Monopolies develop – rich countries = low birth rate which leads to small
- Short term inflation labour workforce.
- Boom and Bust Economic Cycles. If Economic growth is unsustainable then high - External Constraints = trade is key driver of growth.
inflationary growth may be followed by a recession. This occurred in the late 1980s Terrorism, subsidies, taxes, ease of access.
and early 1990s.
Causes of Inflation Measuring Inflation
 Demand-Pull – where Consumer Price Index (CPI)
aggregate demand (AD) 2 surveys
rises at a faster rate than - Expenditure and food survey =
aggregate supply (AS) o Sample of 7,000 households
 AD can increase due to an o Proportion of income spent on purchases, and food
increase in any of its o Weighted. Eg if 10% of income spent on food, then
components C+I+G+X-M 10% of weighting is assigned to food
- Price Survey
 Cost-Push – increases in o Collected once a month
o Basket of 650 items
costs (labour, raw materials,
o Selection of prices
imported costs, etc.) that
o Basket updated each year
cause a leftward shift in AS. o PRICE CHANGE x WEIGHT = PRICE INDEX

Problems Measuring Inflation

Costs of Inflation
Inflation  CPI only measure an average household = Top and
 International competitiveness: high inflation rate bottom 4% income brackets are ignored. So are
will make British goods less competitive, leading to a fall pensioners. Pensioners have different spending habits
in exports. e.g. heating / bus travel account for a higher % of their
 Low consumer confidence: people unwilling to
 Items only changed once a year = Tastes and fashion
spend or invest so firms revenue decreases.
change a lot quicker, so may not be representative and
 Menu Costs: cost of changing prices due to inflation.
does not show people’s spending habits.
 Random redistribution of income: Inflation will  Changes in Quality of goods. The measure breaks
typically make borrowers better off and lenders worse Sustained rise down as it is not comparing like with like. Eg bought a
off. Inflation reduces the value of savings. in price level more expensive mobile this year than last year. Price
 Fiscal Drag: The amount of tax we pay will increase if change might not be result of inflation but because its
there is inflation. This is because with rising wages more been upgraded.
people will slip into the top income tax brackets.  CPI does not include housing costs. Mortgage
 Shoe leather costs: cost in terms of the extra time payments are a large part of household spending. So if
and effort involved in reducing money holdings. CPI rises by only 2% and control inflation. A rise in
interest rates means many people will have higher
mortgage payments.
 Wage increases measured by RPI. More inclusive than
CPI but not as reliable for international comparisons.
Types and Causes of Unemployment Measuring Unemployment
 Cyclical Unemployment 2 surveys
Unemployment from a rise in AD - Labour Force Survey (LFS) =
 Structural Unemployment o Face to face interviews and telephone
surveys of 60,000 households
Caused by decline in demand for certain jobs
o Questions= whether anyone is out of work
or due to changes in demand and supply
for 4 weeks + and can start in next 2
 Technological Unemployment weeks.
Advances in technology causes lack of jobs o More inclusive than claimant as involves
 International Unemployment 16+
Firms move abroad so jobs are lost in local o Time lag – 6 weeks out of date when
- Claimant Count
o Records the no. of people receiving Job
Seekers Allowance
o Not many people are eligible to claim
Costs of Unemployment
o Eg if you resigned from your job or
 Loss of output: waste of resources as Unemployment refused 3 jobs
workforce out of work.
 Lost of tax revenue: less people in work, so
less income thus les tax revenue.
 Government Spending on unemployment
Problems Measuring Unemployment
benefit:  Some people can be seeking jobs but not
 Pressure on other forms: unemployed will claiming JSA
have more health problems and crime.  Sampling errors
Policies to help Unemployment  LFS is very expensive
 Claimant count cannot be international
- Demand side policies to compared

increase AD
- Fiscal Policy
- Lower interest rate
- Stability
Causes of Deficit This is a record of all payments
 High Inflation = This makes exports
A record of money for trade in goods and services
less competitive and imports more plus income flow it is divided into
competitive and expensive. flows in and out
4 parts
 Exchange Rate = a rise in exchange
 Balance of trade in goods
rate will raise exports prices and lower SPICED
import market. (visibles)
 Economic Growth = If there is an  Balance of trade in services
increase in AD and National Income (invisibles) e.g. tourism, insurance
increases, people will have more  Net income flows (wages and
disposable income to consume goods.
Deficit Current Account investment income)
If producers cannot meet the demand  Net current transfers (e.g.
then we have to import a lot more which
govt aid)
leads to a deficit.

Significance of Deficit This is a record of all transactions

 A deficit forms a small percentage for financial investment. It includes
of real GDP = one that lasts a small Net investment from
time is not significant Balance Of abroad (e.g. A UK firm buying
 Deficit may indicate a growing
economy= it could mean a healthy Payments a factory in Japan would be a
debit item)
economy or could mean one with
Net financial flows -
structural problems.
These are mainly short term
 An economy with high inflation
monetary flows such as “hot
and low productivity will have a
money flows” to take advantage of
deficit Financial Account exchange rate changes
Policies to Reserves
Reduce Deficit
Capital Account
 Devaluation = This involves lowering the value of the currency against others.
Opposite to SPICED. Exports cheap imports expensive. This refers to the transfer of funds
 Deflation = If government reduces AD by raising interest rates or taxes people associated with buying fixed
will spend less and reduce consumption of imports. Deflationary policies will also assets such as land
put pressure on manufacturers to reduce costs and competitive exports  Balancing Item
 The success of this policy depends on the elasticity of demand for imports
 However this policy will conflict with other macroeconomic objectives with lower
AD, growth is likely to fall causing higher unemployment.
Flows and House

Wealth Holds

3 leakages
Factors of
Savings Goods and
Tax Services

- Economy will slow down as
less money in the circuit
- The leakages determine the Firms
size of the multiplier

3 injections Multiplier
Investment - The multiplier is the number of times a Wealth Effects
Government spending change in income exceeds the change in - Wealth is the sum of all assets in the economy.
net injections that caused it. - In UK most wealth is held in housing 60% and others
- The importance of the multiplier is that any include shares and capital assets.
- These increase the
change, the final impact is much greater - Wealth is a stock concept whereas income is a flow concept
circular flow and a
change is magnified
than the initial impact. - Wealth does not have a direct impact on circular flow of
- The greater the leakages the smaller the income.
by the multiplier
multiplier - However changes on wealth effect people spending and
- UK multiplier is 1.4 income patterns
- LEDC countries higher = higher growth
Aggregate Demand
Aggregate - AD is the total planned expenditure on goods and services produced in the UK.
Demand - AD = C+I+G+(X-M)
and Supply - Down sloping because:
- Lower prices in economy means increased international competitiveness so more exports and less imports.
- At higher price levels, interest rates are raised. So less investment and increased savings.
- A rise in Aggregate Demand is a necessary condition for a rise in Real National Output. However, if the economy is at full
Capacity (inelastic LRAS) then an increase in AD may not increase real output.
- Consumption
- Main component of AD.
- It measures the amount that consumers wish to spend at various price levels
- Determinants is
- consumer confidence, if consumers are confident then they will spend more
- Interest rates. High interest rates leave consumers with less spending money after housing costs.
- Housing markets. When house prices accelerate home owners can earn more form their houses.
- Investment
- Inverse relationship between interest rates and investment.
- Firms borrow from banks to invest so if high interest rates cost of borrowing rises and firms are less likely to borrow.
- A change in investment will change the level of AD; however a change in AD will also change the level of investment.
- Can be analysed using the accelerator.
- Gov. Spending
- Almost half of all spending in economy
- Does not need to equal tax revenue as the difference is either a budget deficit or surplus.
- The government can deliberately manipulate AD by overspending when there’s is a slowdown in economy. When there’s a boom they tax
more heavily.
- Net spending can also be increased ina recession, which will reverse the effect s of demand deficiency.
- Fiscal policy manipulates gov spending and taxation to change AD.
- Net exports
- Exports minus imports gives total movement of funds
- Reasons why value of net exports might change:
- Change in Exchange Rate = Strong Pound Imports Cheap Exports Dear. Demand for exports will fall and demand for imports rise. The stronger the
currency the worse the net value exports. Short run price elasticity inelastic as deals have been made.
- Changes in Global Economy = if USA have a recession they will buy fewer exports and will try to export more.
- In summary when any AD components rise, the AD curve shift to the right. This happens when any levels rise. They never fall just rise more
Aggregate Supply

- Amount that firms are willing to produce at various price levels.

- Largely influenced by productivity, which in turn is influenced by cost of production, level of investment, supply side policies.

- Keynesian View = The equilibrium level of output can occur below full employment level of output.
- 3 sections: Spare Capacity, Bottle necks, Full employment.
- Spare Capacity
- The economy can increase without any pressure on cost and prices
- This is because there are unused resources as firms are not working at full capacity, or unemployed labour.
- AD would increase e.g. through fiscal policy, and real output would increase without causing an increase in price.
- Bottle Necks
- Constrictions in supply chain cause cost and wage pressure to build up.
- Certain type of labour which when in short supply can have increased prices.
- Eg 2012 Olypicis shortage of construction workers
- If AD increases then while the economy grows there will still be some inflation.
- Full Employment
- Full capacity
- No spare workers, so firms have to offer higher wages to attract workers.
- When AD increases short run extra spending but long run will be increased inflation with no increased output.

- In the Long Run Aggregate Supply is determined by

- Changes in quantity and quality of resources
- Improvements in education and training
- Advances in technology
- In the Short Run Aggregate Supply can be affected by
- Changes of cost in production
- Changes in cost of raw materials
- Change in wages
- Changes in producer tax
Inflation and Unemployment
 Increase economic growth • Employment versus Inflation:
 Control Inflation – Policies to boost employment
may be seen as desirable
 Decrease unemployment
• But:
 Protection of environment – Could trigger economic growth that is too fast leads to
 Restoration of balance of payment inflation?
 Equal distribution if income – A shortage of labour can cause wage pressure to build
up, and people spend causing increase demand and

– High unemployment will cause higher inflation

6 Objectives:
Objectives of Conflicts
Government between

Econ Growth and Balance of Payments

Employment And Environment
• Growth and balance of payments
• Employment and environment
– Econ Growth = Consumer spend and demand for from
– High employment means government has more tax
revenue which can be spent on developing green
– Good = Could be export lead growth which would help B
OF P, as more sold abroad
– Green Taxes
– Growth resulted form increase in AS.
• But:
• But:
– Higher employment means more congestion, more carbon
– Firm’s incentive to export stops.
use, greater energy use
– Spending will worsen the current account.
– People’s income will increase so more travel abroad.
– Less competitive.
Definition: involves using interest rates and other monetary tools to influence
Definition: Government changing the levels of Taxation and
the levels of consumer spending and Aggregate Demand.
Govt Spending in order to influence AD
 UK the target of Monetary policy is to keep inflation within a target of CPI 2% +/-1. They  The Purpose Of Fiscal Policy:
also consider other macroeconomic variables such as growth and unemployment.  Reduce the rate of inflation, (UK government has a target of 2%)
How Monetary Policy Works  Stimulate economic growth in a period of a recession.
The Bank of England study inflationary trends in the economy. This involves looking at a  Basically, fiscal policy aims to stabilize economic growth, avoiding
range of economic variables such as: the boom and bust economic cycle
 Unemployment,
Loose Fiscal Policy
Fiscal Policy

 consumer confidence
Monetary  Spare capacity in the economy 

This involves increasing AD,
Therefore the govt will increase spending (G)

 Exchange rate index and cut taxes. Lower taxes will increase consumers spending
 House prices because they have more disposable income(C)
 Economic Growth  This will worsen the govt budget deficit
 If the Bank of England anticipates inflation falling below the governments target of  Tight Fiscal Policy
2% and economic growth is sluggish or the economy is facing a recession. They  This involves decreasing AD
are likely to cut interest rates.  Therefore the govt will cut govt spending (G)
 Lower interest rates stimulate economic activity, as it reduces borrowing costs.
 And or increase taxes. Higher taxes will reduce consumer spending
This increases the disposable income of consumers with mortgage interest
 This will lead to an improvement in the government budget deficit
payments and should encourage spending.
 Automatic Stabilizes
 If the Bank feels the economy is growing too quickly and inflation is expected to

exceed the governments target, then they are likely to increase interest rates to  If the economy is growing, people will automatically pay more
reduce the rate of growth and inflationary pressures. taxes ( VAT and Income tax) and the Government will spend less
How Monetary Policy Works on unemployment benefits. The increased T and lower G will act as
a check on AD.

 In a recession the opposite will occur with tax revenue falling but
 Liquidity Trap - When a cut in interest rates fail to stimulate economic activity. e.g. because of
increased government spending on benefits, this will help increase AD
low confidence.
 the golden rule: over the economic cycle, the Government
 Difficult to control many objectives with one tool - interest rates. The Bank could increase
interest rates to reduce inflation, but, it would cause economic growth to fall as well. will borrow only to invest and not to fund current spending;

 Changing interest rates has an effect on the exchange rate

 Interest rates may affect some parts of the economy more than others. e.g. higher interest
rates increase the disposable income of people with savings. But, could cause homeowners to
be unable to afford their mortgages. Side

Increasing price flexibility and signalling in a
market = e.g. if government fail to increase
minimum wage then real wages would fall and
 Education / Training =
there would be less unemployment. Firms cost Policies to designed
Investment in education and training and
of production also decreases and AS shift right. to increase AS encouragement to firms to train should
through labour and increase labour and productivity.
Increasing Competition =
product markets  Reduction in Tax =
reducing constraints can
Lower taxes increase incentives to firms
increase competition. As firms
and potential workers.
compete they must either cut
3 ways to Examples  Privatisation =
costs or become more
increase AS
Transfer from public to private. Private
efficient this shifts AS.
sector forms are in the best position to
Privatisation Policies
make decisions about what and how to
Improving Incentives = Function is to give higher Supply  Deregulation =
rewards so people are more motivated.
Side Removal of regulations that affect firms.
Cut marginal tax rates Gives firms greater freedom to make their
Improving health, education, training sector Policies own decisions and increase competition.
Performance related pay and lower corporation tax. Easier for new firms to enter market

Time Lag =
Some policies (education) can
take many years to have an
of polices effect on production costs.
Short run would increase costs

AD continues to rise Selective Side effects on

Enables AD to continue to Targeted at specific Demand
rise over time without markets and not as a Cutting taxes will give
inflationary pressure whole fiscal implications
building up
- Tight monetary policy will have high - Increased Govt spending may be
interest rates. part of fiscal to increase AD.
- This is control inflation but will increase Spending will be directed to health,
cost for firms if borrowing money. education.
- Make exchange rate rise, - Here fiscal and supply work
- Tight monetary policy would worsen together.
supply side, however would help firms - Supply side would cancel out any
export effects of AD shifting right

Monetary Policy Fiscal Policy - However tight fiscal policy

is trying to lower price
VS VS level.
- AS shift left, therefore
Supply side Policy Supply side Policy prices would rise and
Conflicts output contract more than
Between wanted