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Unit 2 Economic Objectives

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rachel holdsworth

on 5 January 2016

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Transcript of Unit 2 Economic Objectives

Unit 2

How the economy works
Economic
Objectives

Low inflation
How is inflation measured?
1. Consumer price index
2. Retail price index
Family Expenditure
Survey
Create
basket
of goods
Give goods
weightings
Do yearly price
comparisons
Why is inflation a problem?
1. Real incomes fall
2. Reduces the value of savings
3. Makes exports more expensive
4. Creates uncertainty in economy
Types of inflation
Demand-pull inflation
Cost-push inflation
A rise in aggregate demand
A rise in the costs of firms
Ways to reduce inflation
Does inflation have any benefits?
Yes, it reduces the burden of debt. Things like mortgages get smaller in real terms if there is inflation.
Reduce Demand
Cut government spending
Increase taxation
Increase interest rates
Problems
Reducing demand may also lead to lower growth and unemployment
Increase supply
Use supply side policies to
increase aggregate supply and reduce inflation
Problems
Can be very slow to work, can be expensive (education), some supply side policies such as cutting welfare payments are unfair on the poor.
Low unemployment
How is unemployment measured?
1. ILO measure
2. Claimant Count
ILO measure is based on a survey
Claimant count is based on people
claiming unemployment-related
benefits
Why is unemployment a problem?
Lost output
Less demand in the economy
Increased Goverment spending
Reduced taxation
Social problems
Types of unemployment
Ways to reduce unemployment
Does unemployment have any benefits?
Yes, if demand is low then it helps to keep inflation under control
Increase Demand
Increase government spending
Reduce taxation
Reduce interest rates

Problems
Increasing demand, while
reducing unemployment may also lead to higher inflation
Increase supply
Use supply side policies to
increase aggregate supply and create jobs
Problems
Can be very slow to work, can be expensive (education), some supply side policies such as cutting welfare payments are unfair on the poor.
Cyclical
Seasonal
Frictional
Structural
Regional
Voluntary
Classical
These policies will continue to increase demand in the long run as the additional spending goes through the multiplier process
Economic Growth
How is growth measured?
Increases in Gross Domestic Product
Add up all the
:

Output
or
Spending
or
Income
Why is low growth a problem?
Lost output
Lower living standards
Higher unemployment
Increased Goverment spending
Reduced income from taxation
Types of growth
Ways to achieve growth
Does low growth have any benefits?
If demand is low then it helps to keep inflation under control
Increase Demand
Increase government spending
Reduce taxation
Reduce interest rates

Problems
Increasing demand, while
reducing unemployment may also lead to higher inflation
Increase supply
Use supply side policies to
increase aggregate supply and create jobs
Problems
Can be very slow to work, can be expensive (education), some supply side policies such as cutting welfare payments are unfair on the poor.
These policies will continue to increase demand in the long run as the additional spending goes through the multiplier process
But sometimes GDP per capita
is not good at showing living standards in a country
You must also take account of:
Distribution of income
Unpaid work
What is produced (guns or food)
Political freedom
Exchange rates

H
uman
D
evelopment
I
ndex is
a better measure of living standards:
Nominal growth

How much the economy has grown
over the past year (eg 3%)
Real growth

How much the economy has grown
over the past year taking inflation into account

Growth = 3% Inflation = 2%
Real growth is 1%

If incomes are low then fewer imports
will be bought.
Improve the Current Account of the Balance of Payments
How is the current account measured?
Balance of visible good
Balance of invisibles (services)
Income transfers
Money transfers
Why is a continual deficit on the current account a problem?
Lower growth
Lower living standards
Higher unemployment
How to reduce the deficit on current account
Lower exchange rate
Makes exports cheaper abroad
Makes imports more expensive

Problems
Governments have little control over exchange rate

If demand for exports and imports are price inelastic, it might make the deficit worse
Protection
Use tariffs, quotas, embargoes and subsidies to protect the UK economy
You can see from this graph what the UK does well and what it does badly
Injections
Exports
Government spending
Investment
Withdrawals
Imports
Taxation
Saving
Exports are an injection into the circular flow of income. Imports are a withdrawal
China and Japan surplus
UK and USA deficit
What is the budget deficit?
When Government spending is greater than Government income (mainly taxation)
What must the Government do if it has a budget deficit?
Sell bonds (borrow)
Print money (QE)
Ways to reduce the budget deficit
Reduce the budget deficit
Cut Government spending and raise taxes
Increase growth

So the government will raise more in taxes and have to spend less on welfare (but this may require spending more and taxing less in the short run)

If we add up all the deficits (and deduct the few surpluses) we get the.....
Public Sector Net Debt (PSND)
Why is a big deficit a problem?
Increases interest payments
Printing money can cause inflation
But what will this do to growth and jobs?
Ways to achieve growth
Increase Demand
Increase government spending
Reduce taxation
Reduce interest rates

Problems
Increasing demand, while
reducing unemployment may also lead to higher inflation
Increase supply
Use supply side policies to
increase aggregate supply and create jobs
Problems
Can be very slow to work, can be expensive (education), some supply side policies such as cutting welfare payments are unfair on the poor.
These policies will continue to increase demand in the long run as the additional spending goes through the multiplier process
Problems
Other countries would retaliate

Membership of the EU and WTO forbids the use of these types of protection
Supply side policies
Pass laws to increase productivity. Increase supply and produce cheaper and better exports
Problems
Can be very slow to work, can be expensive (education), some supply side policies such as cutting welfare payments are unfair on the poor.
Invest in education and training
Cut income tax to increase incentives
Reduce
RED TAPE
(laws on businesses)
Privatisation
Abolish minimum wage
Cut unemployment benefits
Reduce corporation tax
Give grants for research and development
Examples of supply side policies
Ways to reduce inflation
Ways to reduce inflation
A long run solution
Ways to reduce unemployment
Ways to reduce unemployment
Ways to increase growth
Ways to increase growth
Ways to improve the current account of the balance of payments
Ways to improve the current account of the balance of payments
Ways to improve the current account of the balance of payments
Ways to reduce the budget deficit
Ways to increase growth
Ways to increase growth
By John Holdsworth
The relationship between inflation and unemployment was famously shown on the 'Phillips Curve'
Problems with growth
Pollution - (negative externalities)
Greater inequality of income and wealth
Can lead to inflation
People use extra wealth to buy imports
Full transcript