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AS and A Level: Macroeconomics
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The macroeconomic objectives
- 1 Growth is measured usually by the GDP per capita. Be aware that just looking at GDP as a measure of growth is flawed to some extent and know the criticisms of it e.g. ignores the distribution of income, exchange rate problems.
- 2 Full employment – This usually tracks GDP growth to a large extent. Some unemployment in an economy is normal as people change jobs (frictional unemployment) and some would say a little unemployment is useful for preventing big wage rises.
- 3 Low inflation – Inflation is a persistent rise in the level of prices. If a country has inflation its prices are likely to rise compared with foreign competitors so the country will become uncompetitive.
- 4 The balance of payments needs to be in equilibrium, where the value of imports equals the value of exports.
- 5 The most important objective varies – For many years it was the balance of payments and unemployment. Until very recently it was inflation and much more recently, growth has become the most important. Remember that all objectives need to be achieved at the same time.
- 1 The government tries to regulate the economy, mainly by affecting the level of Aggregate Demand (AD) and Aggregate Supply (AS). There are three main types of policy listed below.
- 2 Fiscal policy is using taxation and government spending to regulate AD by, for instance, increasing tax to reduce AD or borrowing more to spend on infrastructure projects to increase AD. Fiscal policy is used less to affect AD recently.
- 3 Monetary policy is essentially affecting the amount of money in the economy by changing the money supply, changing the exchange rate or altering the interest rate. In recent years, monetary policy has mainly come to mean just changing the interest rate with the main aim of affecting AD however quantitative easing is also monetary policy.
- 4 Supply side policies are designed to increase AS by improving the production potential of the economy. Examples include improving education and training, increasing competition for businesses and tax breaks for research and development.
- 5 In practice, governments use all three policies to regulate the economy. Supply side policies are seen as most effective as they also lead to lower inflation but their effects are in the long term.
Keynes versus Friedman
- 1 This is regarded as being a key ideological stand off regarding government regulation of the economy.
- 2 Keynes believed that the government had a big role to play in the economy by regulating aggregate demand. When AD was too low so there was low growth and unemployment, the government should borrow money and embark on public sector expenditure to stimulate AD and the economy. When AD was too high, the government should increase tax or reduce government spending to reduce AD.
- 3 Friedman was a monetarist. He believed that the free market should be left to itself to regulate the economy. He believed that left alone, the economy would provide full employment and growth. The government would only create inflation by injecting money into the economy. The government should regulate the money supply only.
- 4 The dominant ideology changes. From 1945 to 1979, Keynes was dominant. During the 1980s monetarism came back. Now there is arguably a more balanced view.
- 5 Avoid simplistic analysis. The debate concerning the role of the government in macroeconomics is complex.
- Marked by Teachers essays 5
- Peer Reviewed essays 35
Another way in which economic growth may be desirable is that it may lead to an improved fiscal position. Fiscal policy is one of the key economic policies that governments use to influence economic activity and achieve their macroeconomic objectives. If economic growth is rising, then the income of worker's may be considerably higher. If this economic growth is sustainable and stable, then the government may not be pressurised to change spending and tax rates regularly as revenues will tend to be higher and so the position will be more reliable.
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The aim of this essay is to discuss the relevance of John Keynes to the current macroeconomic situation in the UK.5 star(s)
A, 2007: 307). The government of any economy will set policies in order to achieve set economic objectives. These economic objectives include maintaining a stable and sustainable level of economic growth, controlling inflation within a certain level, a push for full employment or decrease in level of unemployment within the economy and monitoring the level of the balance of payments (bized.co.uk). Government policy objectives are highly important as they ensure efficient production of goods and services within an economy. The diagrams below display information relating the changes in different economic objectives over the past years. Inflation can be defined as "an increase in the overall of prices in the economy" (Mankiw G M, 2001: 13).
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When this occurs on a large scale unemployed workers shift into employment. This is beneficial as governments provide less social security for the population, so they can spend money on public services. As a result of increase government spending, the quality of services such as education, health and shelter will become better hence improving the standard of living. Previously unemployed workers will also now be able to afford higher quality essentials. This can be seen in the case of China's HDI which has risen from 0.46 in 1990 to 0.663 in 2010 in correlation to the high level of economic growth experienced during this period.
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I will be evaluating on the article "UK inflation drops to Bank target" by the BBC which only focuses on this problem. Brief summary: The main issue in the article3 star(s)
"an average measure of change in the prices of goods and services bought for the purpose of consumption by the vast majority of households in the UK. It is compiled and published monthly",(National statistics-UK). CPI excludes a number of items that are included in RPI. The CPI however includes the residents of institutional households such as student hostels, and also foreign visitors to the UK while RPI does not. They also have specific differences in price measurement. But, in terms of their basic usability, there is little to choose between them.
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Reduction in income means less spending and therefore lower standard of living. The cost of unemployment worsens the longer a person is unemployed because it affects as he becomes increasingly dejected, suffers from high levels of stress, anxiety and depression. This can further lead to relationship- breakdowns and higher levels of suicide among the unemployed, in extreme cases; especially in countries where the social-support system isn't strong enough. Unemployment, especially long-term unemployment, can pose threat to the society as a whole.
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Fiscal policy would only be used as a short term solution to unemployment and is not sustainable. There are other factors external to the fiscal policy that can limit its effectiveness such as interest rates. Interest rates have substantial impact on the levels of spending by consumers.
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To reduce inflation through monetary policy you must increase interest rates. By increasing interest rates it makes saving more appealing therefore reducing consumer spending, as one of the factors in aggregate demand by reducing consumer spending you ultimately reduce inflation. High interest rates not only reduce consumer spending but also investment, business will be concerned with high interest rates as it becomes more expensive to buy assets, this again reduces aggregate demand. Also people with mortgages will find themselves with lower discretionary income as they are spending more on their mortgage then before.
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An increase in government spending which could be spent on new roads or on education would lead to an increase in AD. These are based on the components of AD which is shown as AD = C+I+G+(X-M). The Central or National Bank uses loose monetary policies to help during a recession in the economy. This involves lowering interest rates which decreases savings and leads to an increase in investment and consumption to push up AD because there is lower opportunity cost associated with investment and consumption.
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figures when using the expenditure measure, it is necessary to remove the distorting effect of expenditure taxes and subsidies. This process is known as the factor cost adjustment and involves the deduction of the value of expenditure taxes and the addition of the value of any subsidies. A further distortion to Yn figures is the rate of increase in prices (inflation), and a statistical adjustment is necessary to remove the impact of inflation. This statistical adjustment is known as the GDP deflator. National income figures are used for measuring changes in the standard of living. In order to increase their accuracy, it is necessary to take account of different population sizes by dividing GDP by the size of the population.
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There could be a disadvantage to pulling the prices up. To begin with, by pulling prices up, in the future, demand will fall and we will see that profits fall for producers, as a result of less revenue. Thus redundancies have to be made as the margin of profit is not enough to subsidise the cost of production, due to profit margins falling. Aggregate Demand Shifts from AD1 to AD2 and so price goes up. (Below) Price AS AD2 AD1 Output When costs rise then eventually these costs will have to be subsidised and the only way to do this is if the cost is passed on to the consumer.
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This component can be positive or negative. c) 3 determinants of Consumption (C):- - Real Disposable Income: main influence on consumer expenditure. The rich tend to spend more than the poor as they have more disposable income. However, their APC (average propensity to consume) may fall as they will probably spend a smaller percentage of their income than a poorer person. - Consumer confidence: This may have a significant influence on consumption, as households tend to spend more if they are optimistic about the future and expecting good job prospects or high wages.
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Explain the possible impact of a world-wide recession on the components of the circular flow of income for a small and open economy such as Singapore.4 star(s)
Being a small and open economy, Singapore have place a strong emphasis on export orientated growth due to our small domestic market, thus resulting in a strong dependence on export revenue to sustain our economic growth. Moreover, with limited domestic investment and the openness to international capital flow, we are more dependent on foreign direct investment (FDI). Therefore, this two components account for a large proportion of the total injections in our economy. As for withdrawals, due to the lack of natural resources and the policy of free trade, we have high import expenditure.
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Discuss the extent to which a reduction in the rate of interest can be effective in increasing consumer expenditure and investment.4 star(s)
Increases in consumer expenditure will most likely increase aggregate demand as consumer expenditure is a component of aggregate demand. Increases in aggregate demand will promote further rounds of spending in the future as unemployment levels will be lower and economic growth will be higher hence giving consumers more confidence to spend more, therefore interest rates are effective in increasing consumer expenditure. Lower interest rates will also increase investment levels within the economy due to the same reasons mentioned above that will increase consumer expenditure.
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Discuss the extent to which an increase in exports will improve an economy's macroeconomic performance.4 star(s)
An increase in aggregate demand would mean an increase in economic growth, which shows good economic performance. Diagram below shows the increase n aggregate demand. Exports will also improve the county's balance of payments. Balance of payments is the net trade in goods, services, investment and transfers. An increase in exports will mean that overall balance of payments will not be in a deficit but in a surplus. An improving balance of payments will also mean that the county's industries and firms are competitive and therefore show that the firms are economically healthy and performing well.
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Over the past few years given the 25% devaluation in sterling our export performance is not that impressive. Firstly, the demand from other countries to buy UK exports has not been too good due to the recent recession. Therefore aggregate demand (AD) decreased leading to a fall in UK exports. The UK has been running a persistent current account deficit for several years, but as the economy emerges from recession and domestic spending will return thus helping growth, import growth has still been stronger than exports. The rest of the world may also have a slow recovery in demand, especially in the European Union where household spending has not been up to scratch.
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On a microeconomic level, inflation can arise from the domestic economy. For example, major energy providers may decide to put up prices in line with projections for the year ahead, or monopolistic supermarket chains could engage in pricing wars, often to the detriment of the consumer and the pocket inflation they experience. Government VAT increases to fund its budget deficit would eventually feed through to inflation. On an international level, various commodity shortages or scarcity power from giant oil companies undoubtedly forces inflation further upwards.
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It is thought that national minimum wages can cause wage unemployment because the employees feel that the work is not worth the minimum amount. * Demand deficient unemployment: This is usually associated during a period of recession in the business cycle. This is because during recessions aggregate demand is low and so firms are more likely to become bankrupt as well as lay-off of employees. * Frictional unemployment: This is transitional unemployment due to people moving between jobs: For example, newly redundant workers or workers entering the labour market may take time to find appropriate jobs at wage rates they are prepared to accept.
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At the very beginning, resources are not being fully used, spare capacity enable an expansion in the production. This process would generate more income without raising too much inflation. In the second stage, part of resources are used up, any increase in demand won't bring any increase in the level of output, but on the other hand, inflation could occur because any increase in prices would discourage potential buyers which cut off the excess demand. Next, almost all the resources are being used up, increase in demand bring no change in the level of output but high inflation in the economy.
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Use the aggregate supply-aggregate demand (AS-AD) model to examine the effects on real GDP and the price level of increases in American tourism to the UK.4 star(s)
The long-run aggregate supply curve is the "relationship between the quantity of real GDP supplied and the price level in the long run when real GDP equals potential GDP"( Parkin, 2000, page 465) . The long-run aggregate supply is shown always as a vertical line and is located at potential GDP. The curve is always vertical because potential GDP is does not depend on the price level. There is no dependence because a movement along the curve is accompanied by changes in two sets of prices: the prices of good and services and the prices of factors of production.
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Examine the factors which affect the international competitiveness of the UK's goods and services (40 marks). International Competitiveness is the ability of a nation to compete successfully4 star(s)
The UK's inflation target is set for RPIX inflation at 2.5% plus 1% or minus 1%. The Bank of England Monetary Policy Committee sets interest rates with the objective to maintain stable or low level of inflation. However even if the inflation rate for UK is high, when comparing with other countries, UK's inflation rate might be lower which means UK will be price competitive with those countries. Exchange rate is the rate between two currencies specifies how much one currency is worth in terms of the other. If the exchange rate is higher for UK's sterling pounds then, the price of UK's export will be high; therefore demand for UK's export will fall, therefore UK will be less price competitive.
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AD represents aggregate demand, which is the sum total of all demands in the economy at any given price. Real Y represents the real (adjusted for inflation) income of consumers. Keynesian 45? Diagram In this diagram, we can see that the level of aggregate demand is lower than the level of output at full employment, therefore the economy is overproducing and a decline in growth will occur. For example, say the level of current aggregate demand is $500, and aggregate demand at full employment is $600. This means that the value of the deflation is $100, that is, people are spending $100 dollars less than they can technically afford to.
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'The trade deficit on goods in the first three months of the year was £7.1bn.' Explain the meaning of this statement.4 star(s)
This is illustrated by the J-Curve effect below. (b) Examine the possible causes of such a deficit. There are a number of possible causes for a current account deficit. Because at a time when some countries will be running a current account deficit, in this case the UK for instance, other countries will be experiencing a current account surplus. Therefore it is essential to identify the underlying causes of a current account deficit before designing policies to correct the problem.
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Assume that, if the price rises, the rate of demand will lead to higher price thus there may be a temporary (short run) rise in real output and low unemployment. However, it may be arises the expectation of higher prices and wages among the people. Besides, if products or services price rises, the demand will go down, thus labour costs will increase the demand of workers fall. This is because firms pursuits to reduce their wage rates by doing discharge their employ.
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The multiplying effect comes into play, when the long term effects of the investment are considered - a more efficient transport network will allow businesses to transport their products more efficiently. The increased efficiency means that the businesses are able to use the saved time/money elsewhere. This again, leads to more opportunity for employment. These newly employed workers now have a greater disposable income - they will be spending more money on goods and services, which increases the profits of businesses.
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Discuss the effectiveness of expansionary monetary policy in achieving an increase in Aggregate Demand in an economy3 star(s)
Furthermore, if interest rates fall, homeowners who have variable rate mortgages, will have a much higher amount of expendable cash to spend (as shown in the graph below). Although, in the short run, homeowners using fixed rate mortgages may not be affected to severely, although, with lower interest rates, there will be an increase in mortgage approvals, and may cause an expansion in the housing market.
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