4.2.3 – Economic Performance

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    4.2.3.1

    – Economic growth – strong economic growth improves standard of living
    There are two different types of economic growth:
    • Short Run Growth – Percentage change in real national output. This is
    known as actual growth (-inflation)
    – Increases in real growth are mainly due to AD increasing
    but can be due to AS
    – Where one of the factors of production is fixed usually
    capital
    • Long Run Growth – Caused by increase in capacity or productive potential.
    – This occurs due to rise in quality or quantity of factors of production eg better
    machines or more skilled labour force
    – Increases in long run growth are done by increasing AS
    • Trend rate of growth = average rate of growth over a period of economic booms &recessions
    • A PPF shows economic growth:

    ▪ A movement from X→B is short run growth as PPF is fixed
    ▪ An increase from A,B or C → Y is long run growth as it increases
    capacity on PPF

    Economic Cycle has Different Phases
    the actual growth of an economy fluctuates over time
    • Boom = economy growing quickly and unemployment low so rising AD causes
    inflation to rise
    • Recession = negative growth for 2 consecutive quarters so
    unemployment rises causing AD to fall and price levels to fall.
    • During recovery the economy goes from negative growth to positive so
    unemployment will fall, causing AD to rise. So inflation will rise
    • Long run growth is an increase in trend rate of growth

    Output Gaps Can Occur during Periods of Boom or Recession
    a negative output gap is when actual output is below trend rate
    o occurs during recession when economy is underperforming as
    some resources are unused or underused (e.g. labour)
    o it means deflation is occurring

    a positive output gap is when actual output is above trend rate
    o occurs during boom when economy is overheating as resources
    are being fully used or overused (low unemployment)
    o so, inflation is occurring

    • During a recovery an economy will go from having negative output gap
    to positive as actual output rises above trend rate of growth
    o Point P,Q,R,S,T are working at full capacity
    o Point U is working at a negative output gap
    o Point V is working at a positive output gap (due to overtime by
    workers)

     

    circle blue shows the economy working at full capacity
    circle red shows the economy working at a negative output gap as theres
    potential to supply more
    • circle yellow shows the economy working at a positive output gap

    Benefits of Economic growth

    ▪ More labour required so reduced unemployment
    ▪ Rise in standard of living as firms give higher wages
    ▪ Firms earn more profit as consumers have higher incomes so spend more
    ▪ Firm Investment increases (better technology)
    ▪ Firms increase output to improving balance of payments as they sell more exports
    ▪ Wages and employment rise so governments tax revenue increases and unemployment benefits reduce
    ▪ Extra revenue from tax can be spent on infrastructure
    ▪ Governments borrow less money due to more tax income
    ▪ Benefits to environment as firms invest in cleaner more efficient production methods
    Costs of Economic growth
    ▪ Can cause income inequality for low skilled workers
    ▪ Higher wages from promotions increasing workload causing stress and reduced productivity
    ▪ Inflation – demand pull (rise in demand > supply) or cost pull inflation (demand for resource rises causing less supply)
    ▪ If more imports are bought by people on higher incomes or by firms in order to meet demand
    ▪ Negative externalities such as pollution, increased congestion on road
    ▪ Finite resources used up which isn’t sustainable for future generations

    Effects of a Recession
    ▪ Negative growth causing unemployment to rise
    ▪ Less investment
    ▪ More government spending as more benefits claimed
    ▪ Makes firms cut costs to survive so become more efficient
    ▪ Discount retailers demand rises as consumer confidence is low
    Short Run Growth created by Increasing AD

    ▪ a rise in AD will cause short run growth. Factors that increase AD are:
    o lowering interest rates
    o increasing welfare benefits raising government spending
    ▪ the size of the shift depends on
    o size of multiplier
    o peoples MPC (higher MPC means larger multiplier)

    Short Run Growth created by Increasing SRAS
    ▪ a factor which reduces production costs will cause a shift in SRAS e.g.
    o a fall in oil price reducing
    o a fall in wages reducing
    Ways to Create Long Run Growth

    ▪ this can be increased by raising the quantity or quality of factors of production for e.g.
    o new technology
    o investment in more modern machinery
    o increased spending on education and human capital
    o increase in population size through immigration

    Economic Instability

    Instability isn’t good for an economy
    ▪ If economy goes up and down for particularly large or frequent periods it can cause problems for an economy
    ▪ Economies can suffer from
    o Demand side shocks
    ▪ Consumer confidence rising e.g. due to house prices rising
    ▪ If country’s major trading partners go into recession reducing demand for exports
    o Supply side shocks:
    ▪ Poor harvest reducing output raising prices
    ▪ New source of raw material making it cheaper increasing output

    Instability can be caused by animal spirits
    • Classical economists believe economic agents act rationally
    • Keynes economists believe economic agents act irrationally
    o They believe humans are guided by instinct and emotion (animal spirits)

    Sustainable growth is difficult to achieve
    • This is economic growth that doesn’t affect future generations
    • The objectives they want to achieve all at the same time are:
    o Expand output each year
    o Find continuous supply of raw materials (land/labour)
    o Reduce negative externalities (pollution)
    • Achieving these at the same time is extremely hard, but will increase countries confidence about long term plans
    • Countries need to
    o develop renewable resources as non-renewable will soon run out
    o develop new technology to reduce negative externalities
    UK’s Recent Macroeconomic Performance
    • From 2000 to 2008 UK enjoyed continuous GDP growth of under 3% each year.
    • But in 2008 a recession occurred for several months followed by slow recovery
    • Recovery had short rises and falls in growth. In 2014 UK had same GDP level as before the recession
    • Inflation has been between 0.5%-3.0% from 2000 to 2015
    • Unemployment remained low between 2000 and 2008 (1.4m- 1.7m)
    • UK economy dominated by service sector which accounts for 77% of GDP

    4.2.3.2 – Unemployment

    Unemployment occurs when a person who is actively searching for
    employment is unable to find work
    Governments Want Full Employment
    • Governments aim for full employment which is where everyone of
    working age who wants a job can find employment at current wage rates
    • Full employment doesn’t mean everyone has a job as in most economies
    people will always be between jobs
    • Full employment maximises output and increases standard of living
    • if there’s unemployment the economy will be at X in the PPF curve but if it is
    at full employment it will be on the PPF curve
    • under employment also causes the PPF to be at X as it’s when someone is
    employed in something they don’t have skills or experience in, so doesn’t
    utilise their potential.
    • labour is derived demand – employer’s demand for labour is derived from consumers demand for goods and services

    There are Four Types of Unemployment

    Seasonal – when demand for labour in certain industries won’t be the same all year round e.g. tourism and farming.
    • This can be regular and predictable and only affects certain industries.

    Cyclical – happens when the economy is in recession so AD falls causing employment to also fall.
    • Countries with negative output is likely to have it as well
    • The cycle follows the positive and negative gaps

    Structural (long term) – a decline in an old industry or occupation due to:
    o technological advances
    o change in consumer preference
    o cheaper alternatives
    • it often affects regions where there’s decline in manufacturing (shipbuilding) and made worse by labour mobility
    o occupational mobility – after their occupation has declined they have no skills to do other jobs available
    o geographical mobility – unwilling to move to from an area with high unemployment to an area with jobs
    available, either due to financial reasons or family reasons
    • structural unemployment leads to the negative multiplier effect as there will be less spending more saving

    Frictional – the unemployment experienced between leaving one job and starting another
    • even if economy is at full employment there’s still some frictional unemployment
    o maybe due to expired contract
    o better job offers with better wages
    • the length of time spent looking for a new job (lag time) varies
    o in a boom, the number of jobs available is higher so frictional unemployment is likely to be short term
    o in a slump, the number of jobs available is lower so frictional unemployment is likely to be long term
    o generous welfare benefits give workers less incentive to find a new job quickly raising frictional unemployment
    o quality of information provided to people looking for jobs, as if they don’t know the jobs available or what skills
    they need to get the job, it’s likely to increase frictional employment
    o occupational and geographical labour mobility will increase frictional unemployment
    Real Wage Unemployment

    • this is caused by real wages being pushed above equilibrium level of employment
    o usually caused by trade unions or if governments introduce national minimum wages
    • introducing NMW above equilibrium wage rate would cause supply of labour to increase and
    demand to fall, causing unemployment between L3 to L2
    Migration
    • migration of workers into country during boom raises national income but during recession
    raises unemployment
    • during recession low-skilled native workers are affected more raising unemployment

    Natural rate of Unemployment
    • The natural rate of unemployment is the difference between those who would like a job at the current wage rate – and
    those who are willing and able to take a job. It includes:
    • Frictional unemployment
    • Structural unemployment.
    • The natural rate of unemployment is unemployment caused by supply side factors. Its determined by
    • Availability of job information
    • The level of benefits
    • Skills and Education
    • The degree of labour mobility
    • Flexibility of labour market

    4.2.3.3 – Inflation

    Inflation can be Cost Pull Inflation
    • Cost-pull inflation caused by rising cost of input to production of goods
    and services
    • Rising costs of inputs force producers to pass on higher costs to
    consumer in the form of higher prices
    • This causes a shift from, AS to AS1

    • Factors that cause raise inputs are:
    o A rise in wages above any increase in productivity
    ▪ If wages are large proportion of firm’s total costs it will raise prices
    ▪ Price rises could cause further wage demands, which could raise price
    o A rise in cost of imported raw materials
    ▪ If countries currency decreases in value then producers pay more for same imports
    ▪ If world prices of inputs rise producers pay the higher cost and set higher prices
    o A rise in indirect tax
    ▪ If government raises indirect taxes it will increase costs and therefore prices
    ▪ If a goods inelastic then more of the cost of tax will be passed onto consumer

    Inflation can be Demand Pull Inflation
    • Demand-pull inflation caused by excessive growth in aggregate demand compared to supply
    • This caused a shift from AD to AD1 which allows sellers to raise prices.


    • It can be caused by
    o High consumer spending or high demand for exports
    ▪ Higher consumer confidence so more spending
    ▪ Low interest rates so more borrowing and spending
    ▪ High foreign demand for exports caused by rapid growth in other country’s
    o The money supply growing faster than output
    ▪ monetarists economists believe excess money is the biggest cause of inflation
    ▪ when amount of money in economy isn’t matched by output of goods and services raising price e.g.
    if theres low interest rates theres more spending
    o Bottleneck shortages
    ▪ If demand grows quickly when labour and resources are already being used up then increasing
    output may lead to shortages
    ▪ These shortages will cause price to rise and firms cost to increase
    ▪ Price rises caused by shortages in one area of market (e.g. rise in wage for skilled workers) may be
    copied by other markets (e.g. higher wages for low-skilled workers) making more general inflation

    Quantity theory of money

     

    Money supply x velocity of money = price level x aggregate transaction MV=PT

     

    this is based on fisher’s equation of exchange
    o M = total amount of money in the economy
    o V = speed at which money is spent
    o P= price level
    o T = total amount of transactions in the economy
    • Monetarists say that in short run V and T are unlikely to change so any increases In P will directly cause M to rise
    • To avoid inflation, monetarists believe the money supply needs to be strictly controlled
    • Both sides of equations are equal to each other, so an increase in M will create same % increase in P
    Costs of Inflation
    • Standard of living falls more so for people on fixed/ low wages
    • Countries competitiveness reduced as exports cost more and imports cheaper
    • If imports rise and exports fall it can cause deficit in balance of payments increasing unemployment
    • Discourages savings as value of money falls so people spend before prices rise further
    • Less saving means less money for borrowing and investment
    • Interest rates rise reducing investment by firms
    • Uncertainty for firms as rising costs will reduce investment
    • Shoe leather cost – to save on losing interest in a bank people will hold less cash and make more trips to the bank
    • An extreme case causes hyperinflation

     

    Consequences of Deflation
    • Deflations a sign of an economy doing badly, as its caused by falling AD and more unemployment
    • Deflation can also be caused by lower costs for firm and these benefits passed onto consumers as lower prices
    • If prices falling consumers may not spend in case prices fall further
    • Less spending and lower prices mean lower profits for firms reducing growth
    Inflation of 2% is Acceptable
    • In UK, the government consider low and stable inflation (up to 2%) to be acceptable. Excessive inflation can
    cause problems and is therefore undesirable
    • Government uses combination of monetary policy, fiscal policy and supply side policies to keep inflation at 2%
    • Monetarists believe bringing down inflation in the short run will help the government in the long run to achieve
    the other main economic objectives

    4.2.3.4 – Conflicts Between Objectives

    Trade-off between Unemployment and Inflation
    • If economy has a rise in AD, it will cause increased output.
    • Once full employment is reached, inflation occurs
    • However, with the increase in real GDP, firms take on more workers
    leading to a decline in unemployment
    • So, with faster economic growth in the short-term, we experience higher inflation and lower unemployment.

    • Monetarists argue that increasing aggregate
    demand will only cause a temporary fall in
    unemployment.
    • In the long run, higher AD only causes inflation
    and no increase in real GDP in the long term.

     

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