Economic growth
Low price inflation
Low rate of unemployment
Exchange rate stability
Long-term balance of payments
Wealth and income transfers to reduce inequalities
There may be conflicts whilst the government is trying to fulfil these objectives, so the government will have to prioritise
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Measured using GDP
It is measured in monetary terms
Inflation will increase the value of GDP, which is not true economic growth
Economic growth occurs as a result of a rise in the real GDP of a country
Negative economic growth (or recession) occurs when GDP falls
Benefits of economic growth:
Increase in average living standards
Higher employment and consumer incomes
Reduction in absolute poverty
More resources available for the government
Rising demand
Increases in output resulting from technological changes and expansion of industry capital
Increases in economic resources, such as a higher working population or discovery of new resources
Increases in productivity
Economies grow at different rates over time
Boom –
Very fast economic growth
Rising income and profits
Rising inflation
Shortages of skilled labour, higher wage rates
Increased interest rates
Recession –
Falling demand
Real GDP growth slows down
House and asset prices fall
Incomes reduce
Profits fall
Slump –
A serious and prolonged recession
Real GDP falls substantially
House and asset prices fall
Recovery and growth –
Real GDP begins to rise
Rate of inflation falls
Products become more competitive
Rising demand
During a recession, output falls, unemployment rises, incomes and demand fall.
Government revenues fall
Demand for normal and income elastic goods reduces
Advantages of recession:
Capital assets become cheaper
Demand for inferior goods rises
Risk of job losses may improve relations
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Increase in the average price of goods and services
Fall in the value of money
Measured using CPI (consumer price index)
It records average changes in goods used by consumers
Compared with previous months prices
Weights are added to these price changes
Then they are averaged and given an index number
Cost push inflation –
Depreciation of the currency
Rising wage rates
Rising raw material costs
Demand pull inflation –
Higher consumer demand
Benefits:
Increase costs can be passed to consumers
Fall in the real value of debt
Increase in value of fixed assets
Increased profit margin as inventory is bought in advance
Drawbacks:
Higher wage demands
Consumers become more price sensitive
Higher rate of interest
Cash flow problems
Uncertainty
Unreliable forecasts
Lose competitiveness overseas
Reduce chances of receiving discounts and credit periods from suppliers
Reduce investment
Lower profit margin
Lower debts and borrowing
Reduce credit period given to customers
Reduce labour costs
Fall in the average price of goods and services
Rise in the value of money
Consumers delay purchases
Discourage borrowing
Firms unwilling to invest
Stocked up inventory reduces in value
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Members of the working force who are willing and able to work, but cannot find a job
Cyclical unemployment
This occurs during the recession stage
During recession, demand falls, encouraging businesses to make employees redundant
Using anti-inflationary policies may lead to cyclical unemployment
If currency appreciates, demand for domestic goods will fall, leading to cyclical unemployment
Structural unemployment
Exists during rapid growth
It occurs due to structural changes in an economy, changing the demand for labour
Causes of structural changes:
Change in consumer tastes and preferences
Increased use of technology, reducing the need to employ workers
Deindustrialisation
Increased need for multi-skilled workers
Provide education and training to workers to avoid structural unemployment
Frictional unemployment
Unemployment when a worker loses their job and are trying to find a new one
May lead to cyclical unemployment
Provide information about job opportunities, open job centres and recruitment agencies, reduce unemployment benefits, etc to reduce frictional unemployment
Social problems – crime
Loss of income and living standards
Inefficient economy, can produce much more
Tax revenue used to support unemployed, opportunity cost
Reduces demand
Skills may become outdated
Records the value of goods and services traded between one country and the rest of the world
Deficit – imports > exports
Problems of a BOP deficit –
Depreciation of the exchange rate
Decline in currency reserves
Reduced Foreign direct investment (FDI)
The price of one currency in terms of another
Exchange rates are determined through the forces of demand and supply
Demand is greater than supply – appreciation – rise in the value
Supply is greater than demand – depreciation – fall in the value
Cheaper raw materials, increased competitiveness
Reduce inflation
Cheaper imports may substitute domestic goods
Higher competition
Cheaper in international markets, increased competitiveness
Lesser price competition in domestic market
Higher cost of imported raw materials
Product design and innovation
Quality of construction and reliability
Effective promotion and extensive distribution
After-sales service
Investment in trained staff and modern technology
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They impact the entire economy
Influence the level of AD and AS
Decisions regarding govt expenditure and tax rates
Revenue > expenditure = surplus
Revenue < expenditure = deficit
During a recession, a government will either raise government spending or lower tax rates, so that AD rises, increasing output and employment
During a period of economic boom, a government will either lower government spending or raise tax rates so that AD falls, lowering inflation, output and employment
Decisions regarding interest rates, money supply and exchange rate of a country
Recession, lower interest rates, increase AD
Higher interest rates will increase costs of production for businesses, lower demand and appreciate the country’s exchange rate
Monetary policy and the exchange rate
Higher interest rates will lead to appreciation of a country’s currency
Reasons:
Speculation
Drawbacks of floating exchange rate & benefits of joining a common currency
Fluctuating prices of imported raw materials
Unstable demand levels
Uncertainty
Difficult to make cost comparison as there is no price transparency
Increased costs
Advantages of not joining a common currency
Central bank can maintain its status as the interest setting authority
Joining a common currency will reduce the independence of each government to control their own tax rates
Interest rates can be used to achieve other objectives, rather than focusing on exchange rates
Joining a common currency, conversion costs will be high
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Supply side policies are ones that aim to increase industrial competitiveness
These include:
Lower rates of income tax – encourage workers to earn more as they don’t have to pay a higher % in taxes
Lower rates of corporation tax – lower tax will increase profits, increasing funds for investment, increasing efficiency and competitiveness
Increasing labour market flexibility and labour productivity –
Subsidize training programmes
Increased funding for higher-education
Lower rates of income tax
Encouraging immigration of skilled workers
Restricting welfare benefits
Subsidies to lower prices
Subsidies to help loss making businesses
Grants to open up in particular locations
Financial supports for consumers
Market failure occurs when there is inefficiency in the market and some goods are overproduced (demerit goods) or under consumed (merit goods)
Private costs and benefits are borne by the people directly involved in production and consumption
External costs and benefits are borne by third partie
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A numerical measure of responsiveness of demand to a change in income
YED = % change in demand/ % change in income
Normal goods – it is positive, between 0 to 1. It means as consumers income increases, demand for these goods rises, by a small proportion
Luxury goods – it is positive, greater than 1. It means as consumers income increases, demand for these goods rises by a greater proportion
Inferior goods – YED is negative. Demand for these goods falls as income rises