A slowdown in consumer demand can create excess opacity and may lead too fall in planned investment demand. I Aggregate demand curve I The aggregate-demand curve shows the quantity of goods and services that households, firms, and the government want to buy at each price level. I Aggregate supply I Aggregate supply (AS) measures the volume of goods and services produced within the economy at a given price level. In simple terms, aggregate supply represents the ability of an economy to produce goods and services either in the short-term or in the long-term.
It tells us the quantity of real GAP that will be supplied at various price levels. The nature of this relationship will differ between the long run and the short run I Animal spirits I Animal spirits refers to the expectations of businesses, entrepreneurs and consumers. When business confidence is high, we expect to see a rise in planned capital investment at each rate of interest. If there is a downturn in business confidence, for example during a recession, then planned investment may fall and some capital investment projects may be scrapped even when interest rates are fairly low.
I Anticipated inflation I Anticipated inflation is expectations about future
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Average earnings comprise basic pay + wage drift (I. E. Extra income from productivity related pay, overtime and there bonuses) I Average rate of tax I The proportion of gross income paid in tax. With a progressive income tax system, the average rate of tax rises as income rises. This is because the marginal rate of tax goes up at certain income levels. I Balance of payments I The balance of payments (BOP) records all financial transactions between the I-J and the Rest of the World.
The BOP figures tell us about how much is being spent by British consumers and firms on imported goods and services, and how successful I-J firms have been in exporting to other countries and markets. I Bank of England I The Bank of England (www. Newfoundland. Co. UK) is charged with the task of ‘maintaining the integrity and value of the currency’. The Bank pursues this objective through the use of monetary policy. Above all, this involves maintaining price stability, as defined by the inflation target set by the growth and high employment.
I Bank of England independence I Since 1997, the Oboe has had operational independence in the setting of interest rates. The Bank aims to meet the Government’s inflation target – currently 2. 0 per cent for the consumer price index- by setting short-term interest rates. Interest rate decisions are taken by he Monetary Policy Committee (MAC) at their monthly meetings. I Budget deficit I When the government is running a budget deficit, it means that in a given year, total government expenditure exceeds total tax revenue. Learn which of the following circumstances usually comes before a period of economic contraction?
As a result, the government has to borrow through the issue of debt such as Treasury Bills and long-term I Bonds I The issue of debt is done by the central bank and involves government selling debt to the bond and bill markets. I Business confidence I The state of business confidence can be vital in determining whether to go ahead with an investment project. When confidence is strong then planned investment will rise. I Business cycle I The business, trade or economic cycle is when actual GAP tends to move up and down in a regular pattern causing booms and slumps (depressions), with recession and recovery as intermediate stages.
I Capital accumulation I The process by which the stock of capital inputs is increased. For the capital stock to grow, gross investment needs to be higher than that required simply to replace worn out or obsolete machinery and technology. Net investment must be positive. I Capital investment I This is investment spending by companies on fixed capital goods such as new plant and equipment and buildings. Investment also includes spending on working capital such as stocks of finished goods and work in progress.
I Central banks I Central banks occupy pivotal positions in the financial systems of their respective countries. In the UK for example, the Bank of England controls the supply of cash into the economic system and has the responsibility for setting official short term interest rates. Most leading central banks are now independent from government and have control over domestic monetary policy. Interest rates inside the Euro Area are now set by the European Central Bank. I Circular flow I The circular low of income is a diagrammatic representation of economic activity in a given time period.
It identifies the main sectors in the economy (households, firms the government and overseas) and linkages between sectors e. G. Wages government spending ; interest payments I Comparative advantage I Comparative advantage exists when a country has lower opportunity cost in the production of a good or service I Consumer confidence I The willingness of people to make major spending commitments depends on how confident they are about both their own financial circumstances, and also the general health of the economy. Consumer confidence is quite volatile from month to month.
Some of the fluctuations are seasonal – but the underlying trend is what really matters. I Consumer spending I Consumers’ expenditure on goods and services: This includes demand for consumer durables (e. G. Washing machines, audio-visual equipment and motor vehicles & non-durable goods such as food and drinks which are “consumed” and must be repurchased). I Corporation tax I Corporation tax is paid on profits. If the government reduces the rate of corporation tax (or increases investment tax- allowances) there is a greater incentive to invest.
Britain has relatively low rates of company taxation compared to other countries inside the EX.. This is a factor that overseas during the last decade. I Cost push inflation I Cost push inflation is caused by increases in costs of production e. G. Wage increases, increased import price (imported inflation) or higher indirect taxation. Firms put up prices to maintain profit margins. Cost-push inflation can be illustrated by an inward shift of the short run aggregate supply curve. The fall in SARA causes a contraction of real national output together with a rise in the general level of prices.
I Current account balance I The current account balance comprises the balance of trade in goods and services plus net investment incomes from overseas assets. (This income in the form of interest, profits and dividends from external assets located outside the UK is also the difference between GAP and GNP). We also add in the net balance of private transfers between countries and government transfers (e. G. I-J government payments to help fund the various spending programmer of the European Union). I Deflation I Price deflation is when the rate of inflation becomes negative. I. E. He mineral price level is falling and the value of money is increasing. Some countries have experienced deflation in recent years – good examples include Japan and China. In Japan, the root cause of deflation was very slow economic growth and a high level of spare (excess) capacity in many industries that was driving prices lower. I Denationalization I Long-term decline in the importance of the manufacturing sector in an economy. We can distinguish between relative decline (e. G. Where the share of total national output accounted for by manufacturing declines) and absolute decline.
I Demand management I Demand management occurs when the government attempts to influence the level and growth of AD hence the levels of national income, employment, rate of inflation, growth and the balance of payments position I Demand-pull inflation I Demand-pull inflation is likely when there is full employment of resources and aggregate demand is increasing at a time when SARA is inelastic. Demand pull inflation is largely the result of AD being allowed to grow too fast compared to what the supply-side capacity can meet.
The result is excess demand for goods and services and pressure on businesses to raise prices in order o increase their profit margins I Deregulation I De-regulation or liberation’s means the opening up of markets to greater competition. The aim of this is to increase market supply (driving prices down) and widen the range of choice available to consumers. The discipline of competition should also lead to greater cost efficiency from producers – who are keen to hold onto their existing market share.
Good examples of deregulation to use include: urban bus transport, parcel delivery services, mortgage lending, telecommunications, and gas and electricity supply. I Direct taxation I Direct taxation is levied on income, wealth and profit. Direct taxes include income tax, national insurance contributions, capital gains tax, and corporation tax. I Discouraged workers I People who leave the active labor force – often because they have been structurally unemployed for a long time and have lost motivation to engage in active Job search. The tax and benefit system may create disincentives for them to search and take Jobs.
The Labor Government’s New Deal programmer seeks to bring more of the discouraged workers back into the active labor supply in the economy. I Discretionary fiscal policy I Discretionary fiscal changes are deliberate changes in direct and indirect taxation and government spending on the road building budget or increase the allocation of resources going direct into the NASH. I Disposable income I Disposable income measures income available for households to spend and is important when looking at the factors that determine consumer spending and saving.
Personal disposable income = Gross I-J Household income – Personal taxation + transfer payments I Economic boom I A boom occurs when real national output is rising at a rate faster than the estimated rend rate of growth. In boom conditions, national output and employment are expanding and aggregate demand is high. Typically, businesses use a boom to raise their output and widen their profit margins by increasing prices for consumers. I Economic growth I Economic growth is best defined as a long-term expansion of the productive potential of the economy.
Sustained growth should lead higher real living standards and rising employment. Short term growth is measured by the annual % change in real national output (real GAP). I Economic recession I A recession means a fall in the level of real national output (I. . A period when the rate of growth is negative) leading to a contraction in employment, incomes and profits. The last recession in Britain lasted from the summer of 1990 through to the autumn of 1992. When real GAP reaches a low point, the economy has reached the trough – and with hope (and perhaps some luck! A recovery is imminent. I Economic recovery I A recovery occurs when real national output picks up from the trough reached at the low point of the recession. The pace of recovery depends in part on how quickly AD starts to rise after the economic downturn. And, the extent to which producers raise output and rebuild their stock levels in anticipation of a rise in demand. The state of business confidence plays a key role here. Any recovery in production might be subdued if businesses anticipate that a recovery will be only temporary or weak in scale.
I Economic slowdown I A slowdown occurs when the rate of growth decelerates – but national output is still rising. If the economy continues to grow without falling into outright recession, this is known as a soft-landing. I Euro Zone I A term for the participating members of the European Single Currency. Twelve nations Joined the new currency zone when it was established in January 1999. | European Central Bank I The European Central Bank (CB) sets a common official rate of interest for the participating members of the single European currency. The CB has an inflation target of 0-2%.
It seeks to maintain the internal purchasing power of the Euro through the use of a Euro Area monetary policy I Exchange rate I The exchange rate measures the external value of sterling in terms of how much of another currency it can buy. For example – how many dollars or Euros you can buy with EYE. The daily value of the currency is determined in the foreign exchange markets (FORE) where billions of $s of currencies are traded every hour. I Exchange rate index I The Exchange Rate Index is a weighted index of sterling’s value against a basket of international currencies.
The weights used are determined by the proportion of trade between the I-J and each country. I Expectations Expectations of consumers and businesses can have a powerful effect on planned expenditure in the economy e. G. Expected increases in consumer incomes, wealth or company profits encourage households and firms to spend more – boosting AD. Similarly, higher expected inflation encourages spending now before price increases an inflow of demand (an injection) into the circular flow of income and therefore add to the demand for I-J produced output.
I Fiscal expansion I A fiscal expansion will cause an outward shift of AD. For example, the Government may choose to increase its expenditure e. G. Financed by a higher budget deficit, – this directly increases AD I Fiscal policy I Fiscal policy involves the use of government spending, taxation and borrowing to influence both the pattern of economic activity and also he level and growth of aggregate demand, output and employment. It is important to realize that changes in fiscal policy affect both aggregate demand (AD) and aggregate supply (AS).
I Fixed exchange rate I In a fixed exchange rate system, the central bank acting on the government’s behalf intervenes in the currency market so that the exchange rate stays close to an exchange rate target. When Britain Joined the European Exchange Rate Mechanism in October 1990, we fixed sterling against other European currencies. The pound, for example, was permitted to vary against the German Mark by only 6% either side of a central target of DAM. 95.
Britain left the ERM in September 1992 when sterling came under sustained selling pressure, and the authorities could no longer Justify very high interest rates to maintain the pounds value when the domestic economy was already suffering from a deep recession. I Floating exchange rate I The I-J is currently operating with a floating exchange rate – where the currency’s value is purely market determined and the Bank of England does not seek to intervene through buying and selling currencies in order to influence the pounds value.
I Foreign exchange market I Currencies are traded around the world in a truly global market with London easily the largest FORE market in the world. The value of most currencies is determined within the foreign exchange markets by the forces of demand and supply. I Free trade I Free trade exists when there are few barriers to international trade between countries. This allows resources to be allocated without the intervention of import tariffs, quotas, and other forms of import controls.
Free trade based on comparative advantage can under certain conditions lead to a rise in economic welfare. Countries can specialist in the production of goods and services in which they have a comparative advantage (lower opportunity cost). I Frictional unemployment This type of unemployment reflects Job turnover in the labor market. Even when there are vacancies it takes time to search and find new employment and workers will remain frictionally unemployed. Improving the flow of information in the labor market is one way of reducing the scale of frictional unemployment.
See also structural and cyclical unemployment I Full employment I Full employment occurs when there is no cyclical unemployment. Some workers will be frictionally or structurally unemployed even at the full employment level of GAP I General Government Spending I This is government spending on state-provided goods and services including public and merit goods. Transfer payments in the form of welfare benefits (e. G. Pensions, Job-seekers allowance) are not included in general government spending because they are not a payment to a factor of production for output produced.
They are simply a transfer from one group within the economy (I. E. People in work paying income taxes) to another group (I. E. Pensioners drawing their Tate pension having retired from the labor force, or families on very low there are barriers preventing people from moving between areas and regions to find work. The I-J housing market is often said to be a major cause of geographically immobility with sharp differences in regional house prices and the relatively weak nature of the rented housing sector making it difficult for people to move between regions.
But family and social ties can be equally important in preventing the geographical mobility of labor. I Golden Rule I The golden rule was introduced into fiscal policy by Gordon Brown when he became Chancellor in 1997. The rule states that government borrowing over the course of the economic cycle should be used to finance government investment spending (so called public sector asset accumulation). Current spending on goods and services together with spending on welfare payments should be financed by current tax revenues.
I Gross capital investment I Gross investment spending includes an estimate for capital depreciation since some investment is needed to replace technologically obsolete and worn out plant and machinery. Providing that net investment is positive, businesses are expanding their capital stock giving them a higher productive opacity and therefore meet a higher level of demand in the future. I Gross domestic product I Gross Domestic Product (GAP) measures the value of output produced within the domestic boundaries of the I-J over a given time period.
GAP includes the output of the many foreign owned firms that are located in the UK following the high levels of foreign direct investment in the I-J economy over many years. I Gross national product I Gross National Product (GNP) measures the final value of output or expenditure by I-J owned factors of production whether they are located in the UK or overseas. I Horizontal equity I Horizontal equity requires equals to be treated equally e. G. People in the same income group should be taxed at the same rate I House price inflation I The annual percentage change in house prices.
There are two commonly quoted measures of house price inflation – from the Halifax ( Britain’s largest mortgage lender) and the Nationwide Building Society I Household Savings Ratio I The household savings ratio is measured as the level of savings as a percentage of disposable income. In recent years there has been a fall in the savings ratio in part because consumer borrowing has reached record levels, lulled in part by the rapid acceleration in house prices. I Human capital I The accumulated skill, knowledge and expertise of workers I Human development index I A composite measure of human development published by the United Nations.
The HID is comprised of components which measure how far each indicator has moved from the minimum value towards a desirable level or maximum deemed attainable. The components of the HID are usually income, life expectancy and education. Wealth and political rights can also be added into the overall calculations. I Hyperinflation I Hyperinflation is extremely rare. Recent examples include Argentina, Brazil, Georgia and Turkey (where inflation reached 70% in 1999). The classic example of hyperinflation was of course the rampant inflation in Whimper Germany between 1921 and 1923.
When hyperinflation occurs, the value of money becomes worthless and people lose all confidence in money both as a store of value and also as a medium of exchange. I Import penetration I Import penetration is a measure of the proportion (or percentage) of domestic demand in a particular market used in energy generation comes from overseas suppliers. Import penetration is also very high in electronic goods industries, textiles and clothing. I Import quota I A quota is a physical limit imposed upon the amount off good that can be imported I Imports I Imports are a withdrawal of demand (a leakage) from the circular flow of income and spending.
Goods and services come into the economy for us to consume and enjoy – but there is a flow of money out of the economic system to pay for them. I Indirect taxation I Indirect taxes are taxes on spending – such as excise duties on fuel, cigarettes and alcohol and Value Added Tax (VAT) on many different goods and services I Inflation I Inflation is a sustained rise in the general price level over time. The rate of inflation is the percentage change in a given price index over the last twelve months I Inflation rate I The rate of inflation is measured by the annual percentage change in the level of consumer prices.
The British Government has set an inflation target of 2% using the consumer price index (ICP). It is the Job of the Bank of England to set interest rates so that AD is controlled and the inflation target is reached. Since the Bank of England was made independent, inflation has stayed comfortably within target range. Indeed Britain has one of the lowest rates of inflation inside the EX.. I Inflation target I The Government’s target for inflation is 2% for inflation measured by the consumer price index (ICP). It is the job of the Bank of England to set interest rates so that AD is controlled and the inflation target is reached.
Since the Bank of England was made independent inflation has stayed within target range – indeed the economy has enjoyed a sustained period of low inflation. I Informal economy I The informal economy refers to undeclared economic activity I Interest rate transmission mechanism I The transmission mechanism between the Bank changing rates and it having an effect on Gag, national output employment and inflation is complex and involves time lags. Interest changes affect household consumption and savings decisions and corporate output and capital investment decisions.
I Interest rates I There is no unique rate of interest in the economy. For example we distinguish between savings rates and borrowing rates. However interest rates tend to move in the same direction. For example if the Bank of England cuts the base rate of interest then we expect to see lower mortgage rates and lower rates on savings accounts with Banks and Building Societies. I Keynes I A British economist who is most noted for his work The General Theory of Employment, Interest, and Money, published 1936. The General Theory formed the foundation of Keynesian economics and created the modern study of macroeconomics.
I Keynesian Consumption Theory I John Maynard Keynes developed a theory of consumption that focused primarily on the importance of people’s disposable income in determining their spending. A rise in real income gives people greater financial resources to spend or save. The rate at which consumers increase demand as income rises is called the marginal propensity to consume. I Labor market incentives I Cuts in income tax might be used to improve incentives for people to seek work and also as a strategy to boost labor productivity.
Some economists argue that welfare benefit reforms are more important than tax cuts in improving incentives – in particular to create a “wedge” or gap between the incomes of those people in work and those who are in voluntary shows total planned output when both prices and average wage rates can change – it is a measure of a country’s potential output and the concept is linked strongly to that of the production possibility frontier I MO (narrow money) I MO (Narrow money) – memories notes and coins in circulation banks’ operational balances at the Bank of England.
Over 99% of MO is made up of notes and coins as cash is used mainly as a medium of exchange. Most economists believe that changes in MO have little effect on total national output and inflation. At best MO is seen as a co-incident indicator of consumer spending and retail sales. MO reflects changes in the economic cycle, but does not cause them. I MM (broad money) I MM (Broad money) includes deposits saved with banks and building societies and money created by lending in the form of loans and overdrafts.
MM = MO plus sight (current accounts) and time deposits (savings accounts). When a bank or another lender grants a loan to a customer, bank liabilities and assets raise by the same amount and so does the money supply. I Macroeconomic equilibrium I Macro-economic equilibrium is established when AD intersects with SARA. The output and the general price level in the economy will tend to adjust towards this equilibrium position. If the general price level is too high for example, there will be an excess supply of output and producers will experience an increase in unsold stocks.
This is a signal to cut back on production to avoid an excessive level of inventories. If the price level is below equilibrium, there will be excess demand in the short run leading to a run down of stocks – a signal for producers to expand output. I Macroeconomic objectives I Government macroeconomic objectives are low and stable inflation & unemployment, high & sustainable economic growth, a satisfactory balance of payments and an acceptable distribution of income I Macroeconomics I Macroeconomics is a part of the subject that considers the economy as a whole.
When we study macroeconomics we look at changes in economic growth; inflation; unemployment ND our trade performance with other countries (I. E. The balance of payments). The scope of macroeconomics also includes an evaluation of the relative success or failure of government economic policies. I Marginal propensity to consume I The marginal propensity to consume is the proportion of each extra pound spent by consumers. If the MAC = 0. Consumers spend app of every extra pound received – they save or use for tax or import payments the remaining I Marginal propensity to import I Consumers in Britain have a high marginal propensity to import goods and services so that when their real incomes are rising and their pending increases, so too does the demand for imports. Unless there is a corresponding increase in I-J exports overseas, then the balance of trade in goods and services will move towards heavier deficit. I Marginal propensity to save I Marginal propensity to save (MSP) = the change in saving divided by the change in income.
The MSP is a component of the function used to calculate the national income multiplier. If the marginal propensity to save rises, then (coteries papyrus) we expect to see a rise in the value of the multiplier I Monetary policy I Monetary policy now involves changes in interest rates to influence the rate of growth of AD. A tightening of monetary policy involves higher interest rates to reduce consumer and investment spending. Monetary Policy is now in the hand of the Bank of England -it in interest rates do not have a uniform impact on the economy.
Some industries are more affected by base rate changes than others (for example exporters and industries connected to the housing market). And, some regions of the British economy are also more exposed (sensitive) to a change in the direction of interest rates. I Money I Money is defined as any asset that is acceptable as a medium of exchange in payment for goods and services I Mortgage equity withdrawal I Mortgage equity withdrawal (also known as housing equity loans) is new borrowing secured on the value of housing that is not invested in the housing stock.
In other words, home-owners can take out housing equity loans to finance major items of spending and add that loan to their existing mortgage. Some people use housing equity loans to pay-off unsecured loans for example on their credit cards. The acceleration in I-J house prices in the last few years has seen a re-emergence of housing equity withdrawal. I Multiplier effect I An initial change in aggregate demand can have a much greater final impact on the level of equilibrium national income.
This is commonly known as the multiplier effect and it comes about because injections of demand into the circular flow of income stimulate further rounds of spending – in other words “one person’s spending is another’s income” – and this can lead to a much bigger effect on equilibrium output and employment. I National debt I The accumulated government debt created through government borrowing when it is running a budget deficit.
If the government manages to achieve a budget earplugs, some of the national debt might be repaid I National income I National income refers to money measurements of economic activity in a country over a period of time I Natural rate of unemployment I The natural rate of unemployment is the unemployment rate at the full employment level of national income where there is no cyclical unemployment but inevitable frictionally and structurally unemployed I Net Exports I Net exports (X-M) reflect the net effect of international trade on the level of aggregate demand.
When net exports are positive, there is a trade surplus (adding to AD); when net exports are negative, there is a read deficit (reducing AD). I Net investment I Economic activity results in capital consumption – machines become worn out and obsolescent. Net investment only occurs after such depreciation of fixed assets is taken into account. Net investment = gross investment – depreciation I New paradigm I New paradigm economists believe that improvements to the supply-side performance of the economy are changing the traditional trade-offs between the main macro-economic objectives.
They argue that the diffusion of information technology is producing large increases in productivity and that these efficiency gains will allow stronger economic growth ND rising employment without risking a sharp acceleration in inflation. The term new paradigm is most widely used in the United States but has also been applied to the strong performance of the I-J economy in recent years. Essentially the new paradigm view believes that the supply-side of the economy can grow sufficiently quickly for policy makers to keep aggregate demand ATA high level.
I Objectives I Objectives are the aims of government policy whereas instruments are the means by which these aims might be achieved and targets are often thought to be intermediate aims – linked closely to the final objective. I Open economy I Britain is goods and services is tied to trade with other countries around the world. Britain is for example the world’s second largest exporter of services (behind the United States) and a significant percentage of our total manufacturing output and employment is directly or indirectly dependent on our performance in international markets, many of which are now intensely competitive.
I Output gap I The output gap is an important concept in macroeconomics. It is defined as the difference between the actual level of national output and its potential level and is usually expressed as a argental of the level of potential output. I Participation rate I Participation rate measures the percentage of the working age population who are active members of the labor force (I. E. Either in paid employment or searching for work). In recent years for example, the participation rate for female workers has increased significantly.
In part this is because of the rapid expansion of tertiary sector employment in the British economy. I Per capita income I Total income divided by the size of the population. Real GNP per capita is used as a benchmark for comparing living standards between countries. However real GNP per head has limitations as a measure of living standards. I Policy trade-offs I There are potential trade-offs between objectives imply that choices may have to be made in the short and medium run – for example possible trade-offs between unemployment and inflation and between economic growth and inflation.
I Potential output I Potential output measures the productive capacity of the economy in a given time period. This is determined by the stock of available factor inputs and their productivity. In the long run, an increase in potential output comes about from an increase in the economically active labor supply and an increase in labor productivity. See also supply-side economic policies. I Price stability I Price stability can be defined as a situation where the rate of change in the general price level is small enough for it not to affect in any meaningful way the long term decisions of businesses and consumers.
When inflation is stable at say 1% or 2%, then expectations of inflation will be fairly stable too and day-to-day, neither businesses nor individuals have little need to factor inflation into their calculations. Price stability does not necessarily mean zero inflation. I Private Finance Initiative I The Conservatives introduced the Private Finance Initiative in 1992 as a way of funding expensive infrastructure developments without running up debts.
Rather than borrowing to fund new projects, John Major’s government entered into a long-term leasing agreement with private contractors. Under a IF, companies borrow the cash to build and run new hospitals, schools and prisons for a period of up to 60 years. So far, about 150 IF contracts have been signed, worth more than Been, with more in the pipeline. I Prevarication I Over the last twenty-five years, many former state-owned businesses eave been privatized – I. E. They have transferred from the public sector into the private sector.
Examples in Britain include British Gas, British Telecoms, British Airways, British Steel, British Aerospace, the regional water companies, the main electricity generators and distributors, and the Railways. British Rail was privatized in 1994 but the failure of Airlock led to the creation of Network Rail, a ‘not for profit’ company in 2002. The Labor Government has continued to privative or part- privative other parts of the I-J public sector since it came to power in 1997.