AS Economics Workbook April 2010 - Y12

AS EconomicsMacroEconomicsRevision Workshop

Student Name

2 AS ECONOMICS Revision Workshop April 2010

Session 1Dissecting the RecessionQuestion 1 In economics, investment is best defined as

A The flow of money into the stock of savings

B Spending on capital goods in the economy

C The profit kept back by firms to finance future spending on new machinery and equipment

D The stock of economic resources such as factories and machinery

Your answer

Actual answer

Question 2 Which one of the following would NOT be regarded as a macroeconomic policy objective?

A Achieving a steady rate of economic growth

B Increasing total investment in the construction industry

C Avoiding a period of time when the general price level falls

D Reducing the employment consequences of the recession

Your answer

Actual answer

Question 3 As a component of aggregate demand, consumption is best defined as

A Spending on all goods and services including imports

B Spending on all goods and services excluding exports

C Spending by households on goods and services

D Spending by households and government including exports

Your answer

Actual answer

Question 4 Cyclical unemployment is most likely to be caused by

A Changes in the demand for labour at different times of the year

B A recession in the country of a major export partner

C A rise in the number of people leaving university with a degree

D The skills of the unemployed not matching those required for the available jobs

Your answer

Actual answer

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Write down the formula for calculating aggregate demand

Understanding the components of aggregate demand (AD)

Consumer spending in the UK fell by 3% in 2009 – the deepest fall for over twenty years – identify four factors that might explain this fall

Focus on consumer spending (C)1 Consumption is the biggest component of Aggregate Demand2 It drives production and profits in the short term3 Consumer spending rarely falls but this recession has been different4 AS requires you to understand what drives consumption and also evaluate its

importance to other macroeconomic objectives

1234


The rise of household saving

One key change in the UK economy has been a sharp rise in the household saving ratio– rising from 0% of disposable income to over 8% in less than two years – what hascaused this and what are the benefits and risks for the UK economy?

Benefits from a higher savings ratio

1

2

3

4

Risks from a rise in saving

1

2

3

4

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Evaluation – the significance of consumption for other macroeconomic objectives

In 2009 UK household spending fell sharply – explain how this might affect

The government budget deficit

The balance of trade in goods and services

Business investment spending

Inflationary pressures

Unemployment

Price Level

Real Output

LRAS

AD

Consumption and AD-AS analysis


Business investment spending (I)

Identify four determinants of business capital investment spending

1

2

3

4

Evaluation: Why is the 15% fall in investment during the recession significant?

1

2

3

4

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Dissecting the causes and consequences of the recession

Recessions have many explanations… can you think of five relevantcauses of the UK downturn from 2008 – 2009?

1

2

3

4

5

In this section we look at causation and consequence – How bad has the recession been? What have been the major causes and effects? Are there advantages from a recession?

Key evaluation point: A cycle in one country can affect economic activity in others – theUK economy is vulnerable to external shocks affecting aggregate demand and aggregate supply


Consequences of the recession

Price Level

National Output

LRAS

AD1

Y2 Y1

AD2

SRAS

Summary notes on how the UK recession has affected:

1 Business profits

2 Labour productivity

3 Unemployment

4 The level of spare capacity (output gap)

5 The national debt

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Possible long term effects from the recessionThis links in with session 2 on the supply-side of the economy.

NationalOutput

Time

Trend

A deep recession may cause damage to aneconomy’s potential growth rate

Some of the lost output may be unrecoverableand the trend growth rate in a recovery mightbe slower than in the past

Multiplier and accelerator effectsYou need to have a basic understanding of the multiplier effect and the accelerator process.

The Multiplier Effect


Question 5 Which one of the following is most likely to occur in the boom phase of an economic cycle?

A Rising national income, falling unemployment & a negative output gap

B Rising imports, rising profits and a positive output gap

C Rising consumption and investment and a negative output gap

D Excess demand, falling employment and a positive output gap

Your answer

Actual answer

Question 6 The ‘multiplier’ usually refers to the final effect of a change in the level of?

A Aggregate demand upon imports

B National income upon aggregate demand

C Saving upon investment

D Exports upon national income

Your answer

Actual answer

Describing the Accelerator Process

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Question 2 Which one of the following is most likely to achieve an increase in an economy’s underlyingtrend rate of growth?

A A rise in inflation

B A rise in labour productivity

C A rise in labour productivity

D A rise in household disposable income

Your answer

Actual answer

Question 2 All other things being equal, which one of the following is most likely to cause a simultaneousshift to the right in both an economy’s short-runand long-run aggregate supply curves?

A An increase in the rate of interest

B An increase in the number of immigrant entering the country

C A increase in the rate of Value Added Tax (VAT)

D An increase in the national minimum wage rate

Your answer

Actual answer

Your answer

Actual answer

Question 3 A supply-side policy can be used to increase

A Interest rates

B Government spending

C Tax rates

D The mobility of labour

Your answer

Actual answer

Question 1 The underlying long-run trend rate of economicgrowth can be defined as the?

A Rate of economic growth that can be maintained in the long run

B Highest rate of growth achieved in the long run by an economy

C Average rate of economic growth in a boom period

D Rate of growth achieved for a period of more than twoquarters

Session 2 Supply-side policies and the long-run performance of an economy


Supply-side policies in action

We will go through some examples of supply-side policies from the UK and other countries –this is an area where good examples can really help your answer.

Policies to stimulate enterprise

Policies to promote innovation

Policies to improve productivity

Policies to improve mobility

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Why are successful supply-side policies important?

All governments give emphasis to improving the supply-side – why is this? In this section we link the effectiveness of supply-side policies to a range of economic policy objectives.

NationalOutput

Time

Trend

Notes on the importance of supply-side policies in these policy areas

1 Unemployment

2 The Balance of Payments

3 Underlying economic growth rate

4 Controlling inflation

5 Improving the environment

6 Raising living standards and reducing poverty

Supply-side policies and the trend growth rate – a good diagram to use


Supply-side policies - using AD/AS diagrams to show a rise in productive potential

Evaluation points on supply-side policies

Price Level

National Output

LRAS

Yf1

When writing about supply-side policies in the UK remember to focus on the global nature of the economy and the importance of the economy remaining competitive in domestic andoverseas markets. The challenges from emerging market countries are especially important.

Many of these policies have long time lags!

Level of demand is important in making investment and innovationviable

Some risks of over- investment – leaving excess capacity (examples of countries here?

Most supply-side improvements come fromthe private sector

Sustainability issues if policies raise a country’slong term growth rate

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Focus on two supply-side indicators


Question 5 The diagram below shows two long run aggregate supply curves for atequilibrium at Y1. In order to move the economy to Y2, a government might

A Try to lower the value of the exchange rate

B Increase the level of taxation on business

C Reduce expenditure on the national health service

D Reduce the level of tax on profits that flow from new patents

A Stay at W

B Move to Z

C Move to Y

D Move to X

Question 5 The diagram below the AD and SRAS curves for an economy that is initially in equilibrium at W. Following a 20% rise in imported raw materialprices and a fall in export sales due to a recession in a major trading-partner economy, equilibrium is likely to

Price Level

Output

LRAS1

Price Level

Output

SRAS2X

Y

WZ

SRAS1

AD2AD1

LRAS2

Y1 Y20

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Session 3 UK Economy in Focus –Issues facing the UK economy in 2010 and beyond

Issues Facing the UK Economy

In this special macroeconomics presentation we will consider key recent developments in the UK economy and try to connect as many different partsof the AS Unit 2 course together as we can. How strong is the economic recovery likely to be? What are the main risks for the UK economy in themonths and years ahead? Are there reasons to be cheerful?

During this presentation jot down arguments and ideas that you find most relevant – and usethis as a great chance to show the examiner that you are right up to date with important developments in the UK and world economy! This will boost your evaluation marks!


Session 3 Study Notes

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Session 4Managing the EconomyWe will look at lessons from the credit crunch and recession andrevise the ways in which monetary and fiscal policies have beenused both in the UK and overseas to stabilize the economy.

A quick reminder on the two main policy options for individual governments / central banks

Monetary Policy• Changes in policy interest rates• Quantitative easing (QE)• Changes in the exchange rate

Fiscal Policy• Automatic stabilisers• Changes in government spending• Changes to direct and indirect taxes• Changes to the level of government borrowing

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Check your understanding of monetary policy

Question 1 Which one of the following statements about monetary policy is correct?

A A cut in interest rates always increases inflation

B While reducing excess demand, higher interest rates maycause cost-push inflation

C Interest rate changes have no effect on aggregate supply

D An increase in interest rates will increase business investment

Your answer

Actual answer

Question 2 All other things being equal, a rise in the valueof the pound on the foreign exchange markets is most likely to increase?

A The rate of inflation in the UK

B The level of interest rates in the UK

C The UK’s current account deficit on the balance of payments

D The volume of UK goods and services exported overseas

Your answer

Actual answer

Question 3 Expansionary monetary policy is most likely to

A Shift the long run aggregate supply curve to the left

B Result from a reduction in taxation

C Cause a trade surplus on the balance of payments

D Reduce the amount of spare capacity in the economy

Your answer

Actual answer

Question 4 In March 2009 the Bank of England continuedthe trend of falling interest rates by cutting thebase rate to 0.5%. One justification for thismight have been the MPC’s concern over

A Changes in the demand for labour at different times of the year

B A recession in the country of a major export partner

C A rise in the number of people leaving university with a degree

D The skills of the unemployed not matching those required for the available jobs

Your answer

Actual answer


Monetary policy involves changes in

• Policy interest rates (and other interest rates in the economy)• The exchange rate• The availability of credit

To influence

• The level and growth of aggregate demand and output• Control inflationary and deflationary pressures• Meet an inflation target and achieve price stability

Monetary Policy

Recent changes in UK interest rates

Your notes on the recent changes in UK interest rates

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Why has the Bank of England cut interest rates to such low levels?

1 Response to the credit crunch

2 Risks of deflation

3 To prevent a depression

4 To stabilize confidence and demand

Freezing ofcredit supply

HigherInterest rates

Increasedrisk of default

on loans

Hitspersonal

sector wealth

Fall in consumerborrowing andhouse prices

A Quick Return to the Credit Crunch


How rates affect the economy – analysis and evaluation

A change in interest rates affects AD, output and inflationary pressure in several ways.

Consider the decision to cut interest rates below 1%

Your notes

Consumer and BusinessConfidence

The cost ofborrowing and the cost of servicing existing debts

Effects on the housingmarket

The incentiveto save

The value ofthe exchangerate

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Evaluation points on interest rates and the economy

Low interest elasticity of demand especially in a recession

Fixed interest rates for many borrowers

Impact on savers especially older people

Time lags for interest rates to work


Quantitative Easing

The Bank of England introduced a policy of quantitative easing in March 2009. The Bank ofEngland has bought up to £200 billion of assets - mainly government bonds financed by theissuance of new central bank reserves.

Exchange rates and economic performance

It is important to realize that movements in the exchange rate – the purchasing power of onecurrency against another – form part of monetary policy. We have seen big changes in thevalue of the pound (sterling) in currency markets over the last two to three years – here issterling against the US dollar.

Bank ofEngland creates

new money

Buys bonds -drives bond

prices higher

This lowers theyield (interestrate) on bonds

Commercialbanks now havemore deposits

shouldstimulate more

lending

Boosts demandin economy

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Economic benefits and costs from a lower exchange rate

Advantages of a lower £ against the Euro

Overseas demand for UK exports

Expenditure-switching away from imports

Value of overseas investment and subsidies

Multiplier and accelerator effects

Consider an exchange rate depreciation for the pound against the Euro.

Has the lower pound helped? Some evaluation points

Analysing the possible effects using an AD/AS diagram

Price Level

National Output

LRAS

Yf1

Disadvantages of a cheaper pound v the Euro

Costs of imported components & raw materials

Costs of imported technology products

Inflationary dangers

Risks for foreign investors


Fiscal policy – aggregate demand and supply effects

Taxes Subsidies

Budgetdeficit

Govtspending

Our focus here is mainly on how fiscal policy has been used to manage the economy during thefinancial crisis and recession. But it is important to understand that fiscal policy decisions affectboth aggregate demand and aggregate supply. Indeed many of the fiscal stimulus policies of thelast few years might also have significant effects on aggregate supply.

Fiscal stimulus policies in the UK during the recession

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Economics of the budget deficit

Fiscal policy has been used to actively manage demand in the UK during the recession. A rising budget deficit is an expansionary fiscal policy. But borrowing money on such a hugescale invites an evaluation about the benefits and costs of running a large budget deficit.

Justifying higher government borrowing Economic risks of a high budget deficit

Building a good evaluation discussion


Test your understanding of fiscal policy

Question 1 A budget deficit

A Means that the value of imports are greater than exports

B Will lead to an increase in the National Debt

C Will help to reduce aggregate demand

D Will lead to a reduction in interest rates

Your answer

Actual answer

Question 2 Which one of the following is an example of acontractionary fiscal policy designed to reduce inflationary pressure?

A An increase in the government budget surplus

B A reduction in the exchange rate

C Higher interest rates

D An reduction in the rate of tax on business profits

Your answer

Actual answer

Question 4 An economy finds itself in a position where actual GDP is below Trend GDP and is predictedto fall further. What combination of policies is itmost likely to implement in this situation

A Higher taxes with lower interest rates

B Higher taxes with higher interest rates

C Lower taxes with lower interest rates

D Lower taxes with higher interest rates

Your answer

Actual answer

Question 3 According to Keynesian economists, for whichone of the following types of unemploymentmight an increased budget deficit be the mostappropriate policy?

A Frictional

B Structural

C Cyclical

D Technological

Your answer

Actual answer

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Session 5 Techniques for scoring high marks on data questions

Data Description Tips

Many early questions on the paper ask you to describe data shown in a chart or table. Question commands might include:

• Using the data identify two components from the table that have led to an improvement in the current account of the UK balance of payments

• Using the extract, identify two main features of the annual growth of UK labour productivity for the period from 2002 to 2007

• Using the extract, identify two points of comparison between the changes in the bank interest rate and the consumer price inflation rate between 2004 and 2007

Using Extract 1, identify two points of comparison between the changes in UK real GDP and UK unemployment between the years 2004 and 2009


Tips for scoring high marks on evaluation questions

Evaluation questions carry the highest marks and the quality of you answer will make a hugedifference to your final grade. We will offer our suggestions for doing well on evaluation.

Some recent evaluation questions on Unit 2 papers:• Using the data and your own knowledge, assess the importance of higher labour

productivity in bringing about improvements in UK macroeconomic performances• Assess the view that a fall in the exchange rate of the pound will help improve the

performance of the UK economy• Assess the view that inflation is always caused by an increase in aggregate demand• Assess the view that rising consumer spending is always good for the UK economy• Evaluate alternative measures that can be used to reduce unemploymenty

Evaluate alternative measures that can be used to reduce a trade deficit

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Some good evaluation phrases

In the Exam Room


UK Economy at a GlanceRecession Recovery

2009 2010 Comment

Consumer -3.1 0.4 Modest rebound in spending - tax rises, high spending unemployment and continued need to repay

debt

Government 2.0 1.7 Squeeze on real government spending likely consumption to be delayed until 2011 when the Politics is

settled

Investment -14.4 -0.5 Deep cut in capital spending last year - lesssevere in 2010 but weak demand holds backinvestment

Stockbuilding -1.2 1.0 Many firms cut back on stocks/ production in(% GDP) 2009, signs of a recovery in inventories in

2010

Domestic demand -5.1 1.6 Overall C+I+G was strongly negative in 2009(a largely home-made recession?) Weak againin 2010

Exports -10.9 4.8 Exports hit by sharp fall in global output/tradein 2009. More positive in 2010 - weak sterlinghelping?

Imports -12.1 3.0 Imports slumped as UK went into downturn(UK has high income elasticity of demand forimports)

GDP -4.9 2.0 Deep recession (-6.2% over course of recession) - scraping towards 2% growth in2010 (the new trend?)

Manufacturing output -10.4 3.2 Collapse in industrial output in 2009 but moresigns as industry benefits from weak pound

Unemployment LFS) 7.6 7.7 Unemployment to stay lower than in themeasure (%) last recession - fewer hours and wage cuts

have helped

Unemployment CC 4.9 6.1 Claimant count also likely to peak belowmeasure (%) 2 million - but long term unemployment is a

worry

Labour force (million) 31.4 31.2 Small shrinkage in size of labour force - partlyreverse migration and discouraged worker effect

Average earnings -0.1 3.4 Negative earnings growth for millions in(inc. Bonuses 2009 - pay cuts and pay freezes (but CEO

pay remained strong)

RPI Inflation -0.5 3.8 Some deflation in 2009 (mainly due to bigcuts in mortgage interest rates) - RPI spikeshigher in 2010

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CPI Inflation 2.2 2.8 CPI has remained above target during the recession - policy makers happy to ignore thisfor now

Real wages -1.0 -2.6 Important data - in this recession, real(deflated by CPI) wages have fallen for a significant number

(wage flexibility?)

Productivity -3.2 3.0 Drop in productivity in 2009 explained(output per worker) by weak output - but also long term factors

limiting efficiency

Unit labour costs 4.3 -3.4 2010 will see a fall in UK unit labour costs - (ULCs) an improvement in competitiveness which will

help

BoP Current Account -1.1 -0.7 UK heading back to balance / (% GDP equilibrium on the balance of payments, not

really a policy issue

Budget Balance -11.0 -10.1 This is the big macro policy issue - how much(% GDP) borrowing can be sustained? When to

squeeze policy?

Government debt 68.6 80.3 Sharp rise in government debt (% of GDP) (although lower than many EU countries) and

much debt is long-dated

US Dollar /Sterling $1.57 $1.61 Relative exchange rate stability against the dollar? Hard to forecast - many UK importspriced in Ss

Sterling / Euro Euro 1.11 Euro 1.09 Euro set to gradually strengthen against sterling despite woes of the PIGS

Base (policy) 0.5 0.5 Policy interest rates set to remain interest rate (%) below 1% for at least the rest of the year -

MPC in wait and see mode

10-year government 4.1 3.4 Where next for bond yields? Much depends bond yield (%) on election result and credibility of new govt

fiscal plans


AS MACRO Key Term GlossaryAccelerator effect Where planned capital investment is linked positively to the past

and expected growth of consumer demand.Animal spirits The state of confidence or pessimism held by consumers and

businesses.Appreciation A rise in the market value of one exchange rate against anotherAutomatic stabilisers Automatic fiscal changes arising automatically as the economy moves

through different stages of the business cycle - for example a fall taxthat the government takes out of the circular flow in a recession.

Bank run When a substantial number of depositors suspect that a bank may go bankrupt and withdraw their deposits. Bank runs are rare but onehappened with the Northern Rock in the autumn of 2007.

Bond Both companies and governments can issue bonds when they need toborrow money. The issue of new government debt is done by the centralbank and involves selling debt to capital markets.

Budget deficit Occurs when government spending is greater than tax revenues. TheUK budget deficit in 2009-10 is forecast to be more than 12% of GDP.

Business confidence Expectations about the future of the economy – vital in business decisions about how much to spend on new capital goods.

Capacity utilisation Measures how much of the productive potential of the economy is being used. Utilisation falls during a recession.

Capital stock The value of the total stock of capital inputs in the economyCapital-labour Replacing workers with machines in a bid to increase productivity.substitution This can lead to structural unemployment.Catch-up effect This occurs when countries that start off poor tend to grow more rapidly

than countries that start off rich. The result is some convergence in thestandard of living as measured by per capita GDP.

Claimant Count The number of people claiming unemployment-related benefits. SinceOctober 1996 this has been defined as the number of people claimingJobseeker's Allowance.

Classical LRAS The classical LRAS curve is drawn as vertical because classical economists argue that a country’s productive capacity is determined byfactors other than price and demand such as investment and innovation.

Comparative advantage Comparative advantage refers to the relative advantage that one countryor producer has over another. Countries can benefit from specializing inand exporting the product(s) for which it has the lowest opportunity costof supply.

Corporation Tax A tax on the profits made by companies.Constant prices Constant prices tells us that the data has been inflation adjusted.Consumer confidence Expectations about the future including interest rates, incomes and jobs.Consumer durables Products such as washing machines that are not used up immediately

when consumed and which provide a flow of services over time.Credit crunch Situation where banks across the economy reduce lending to each

other due to falling confidence that loans will be repaid. This restrictsthe flow of money around the economy and can result in less creditbeing available for consumers and businesses, resulting in an increasein the cost of obtaining credit.

Current account of the The overall balance of credits minus debits for trade in goods, tradeBalance of Payments in services, investment income and transfers.

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De-industrialization A decline in the share of national income from manufacturing industries.Deflation A persistent fall in the general price level of goods and services.Depreciation A fall in the market value of one exchange rate against another.Depression Used to describe a severe recession which may become a prolonged

downturn in the economy and where GDP falls by at least 10 per cent.Deregulation Reducing barriers to entry in order to make a market more competitive.Discouraged workers People often out of work for a long time who give up on job search.Discretionary fiscal Deliberate attempts to affect aggregate demand using changes inpolicy government spending, direct and indirect taxation and borrowing.Discretionary income Disposable income adjusted for spending on essential bills such as fuel. Dumping When a producer in one country exports a product to another country at

a price which is either below the price it charges in its home market or isbelow its costs of production.

Ecological debt Ecological debt is the concept that people’s demands have exceededthe Earth’s ability to cope with the rising consumption of its resources.

Economic cycle Variations in the annual rate of growth of an economy over time.Economic shocks Unpredictable events such as volatile prices for oil, gas and foodstuffs.Economic stability When the main indicators such as growth, prices and unemployment

do not change much from one year to another.Expectations How we expect the future to unfold – this can have powerful effects on

the spending decisions of households, businesses and the government.Fine-tuning Changes in monetary policy or fiscal policy designed to gradually

manage the level of aggregate demand and prices.Forecast A prediction made about the likely future performance of an economy.Free trade When trade between nations is allowed to occur without any form of

import restriction.Full capacity output A level of national output where all available factor inputs are fully

employed – this is a factor influencing the underlying growth rate.

Full employment When there enough job vacancies for all the unemployed to take work.

G7 A group of seven major industrialized countries: Canada, France, Germany, Italy, Japan, the UK and the USA.

G20 A group of finance ministers and central bank governors from 20economies, the G20 is a forum for cooperation on key issues.

GDP The monetary value of the output of goods and services produced inside a country – regardless of ownership.

Gini Coefficient The Gini coefficient is a measure of the overall extent to which groups of households, from the bottom of the income distribution upwards, receive less than an equal share of income.

Globalisation The deepening of relationships between countries of the world reflectedin an increasing level of overseas trade and investment.

GNI Gross National Income – income generated from the resources ownedby inhabitants and businesses of a given country.

Golden Rule A rule introduced by the Labour government which says that borrowingon state provided goods and services should be zero over the course of one economic cycle. Borrowing is allowed when it finances capital investment.

Hard landing A full-scale recession shown by a decline in real national output.


Hot Money Money that flows freely and quickly around the world economy lookingto earn the best available rate of return. It might be invested in any assetwhose value is expected to rise (e.g. property or shares) or simply beplaced in an account offering the best real rate of interest.

Household wealth The value of assets owned by households – including property, shares,savings and pension fund assets.

Immobility of labour Barriers to the movement of people between areas and between jobs.Income elasticity Responsiveness of demand to a change in the real income of consumers.of demandInflation target The Government sets the Bank of England a CPI inflation target, which

is currently 2 per cent. When inflation rises or falls more than 1% aboveor below the target, the Governor of the Bank of England must write anopen letter to the Chancellor of the Exchequer to explain why.

Inflationary pressures Occurrences likely to lead to price rises. These can come from both thedemand and the supply-side.

Innovation Changes to products or production processes – innovation is importantin delivering improvements in dynamic efficiency.

Interest elasticity The responsiveness of demand to a change in interest rates. This isof demand relevant in discussing the effects of changes in monetary policy.International Monetary The International Monetary Fund (IMF) is an organisation of 186Fund (IMF) countries, promoting global monetary cooperation, financial stability,

international trade, employment and sustainable economic growth. It has provided help for several nations in the wake of the 2007-09 financial crises.

Inventories These consist of materials and supplies which are stored for use in production, work-in progress, finished goods and goods for re-sale.

Investment Spending on capital goods including plant & machinery and infrastructure.Investment income Interest, profits and dividends from assets owned and located overseas.J Curve Effect The effect of currency depreciation on the trade deficit depends on

price elasticity of demand for exports and imports. In the short term, demand is often inelastic and the J Curve effect says a trade deficit canactually worsen after depreciation, but get better in the medium term.

Job search The process by which workers find appropriate jobs given their tastesand skills.

Keynesian Unemployment caused by a lack of aggregate demand in the economy.unemploymentKeynesian economics The economics of John Maynard Keynes. The belief that the state can

directly stimulate demand in a stagnating economy. For instance, byborrowing money to spend on public works projects like roads, schoolsand hospitals.

Labour shedding Cut backs in employment often seen in a slowdown or a recession.Labour shortages When businesses find it difficult to recruit the workers they need.Labour supply The number of people able, available and willing to work at prevailing

wage rates.Lagging indicators Indicators which tend to follow economic cycles e.g. unemployment.Leading indicators Indicators which predict future economic trends e.g. consumer

confidence.Leveraging The use of borrowed funds to increase your capacity to spend or invest.

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LIBOR Libor stands for the London Interbank Offered Rate and is used bybanks world-wide to determine the rate at which they lend to each other- whether that’s receiving or giving loans (including 24 hour - 5 yearloans). Libor rates are set daily and released at the same time everyday -11am London time.

Life-cycle model A theory that says that savings rates depend on how old someone is.Liquidity Liquidity refers to the ease with which something can be converted to

cash with little or no loss of value.Macroeconomic The overall performance of an economy in terms of output, prices, jobs,performance global trade and living standards. Marginal propensity The proportion of any change in income that is spent rather than saved.to consumeMarginal propensity The change in total saving as a result of a change in income.to saveMarginal rate of tax The rate of tax on the next unit (£) of income earned.Misery index A measure of welfare calculated by adding together the unemployment

rate and the rate of inflation. Monetary Policy The MPC is a Bank of England committee of nine people which meetsCommittee every month to set interest rates. Money supply The entire quantity of a country's commercial bills, coins, loans, credit,

and other liquid instruments in the economy.Multiplier effect If there is an initial injection (e.g. a rise in exports) into the economy

then the final increase in AD and Real GDP will be greater.National debt The total amount of debt that the government owes the private sectorNationalisation The act of bringing a privately owned asset, such as a company or

property, under state control.Negative equity Negative equity occurs when the value of an asset falls below the

outstanding debt left to pay on that asset. Term is most commonly usedin connection with property prices and describes a situation where themarket value of a house is less than the existing mortgage debt.

Net investment Gross investment minus an estimate for capital depreciationNet inward migration When the number of migrants coming into a country is greater than

those leaving in a given time period.Net Trade The balance between the value of exports and imports. E.g. in 2009

the UK ran a trade deficit in goods and services of £40bn.Nominal GDP This is the monetary value of all goods and services produced in the

economy expressed at current prices.Non-inflationary growth Sustained growth of real national output whilst maintaining price stabilityOutput gap The difference between actual and potential national output. A negative

output gap after a recession implies that an economy has a large marginof spare productive capacity.

Overseas assets Assets such as businesses, shares, property which are owned in overseascountries and which might generate a flow of investment income whichis a credit item on the current account of the balance of payments.

Peak The high point of the economic cycle beyond which a recession starts.Per capita incomes Income per head of the population – a measure of average living standardsPhillips Curve A statistical relationship between unemployment and inflation.Policy asymmetry When a given change in interest rates affects different groups or

different countries to a lesser or greater degree.


Precautionary saving Saving because of fears of a loss of real income or employment.Price stability Price stability occurs when there is low inflation and the price changes

that do occur have little impact on day-to-day decisions of people.Productive potential The productive capacity of the economy – boosted by high quality

investment.Productivity A measure of efficiency e.g. measured by output per person employed

or output per person-hour.Propensity to import The proportion of any change in income that is spent on overseas

products.Propensity to save The proportion of any change in income that is saved rather than spent.Protectionism Restricting trade through tariffs and other forms of import controls.Quantitative easing Central banks flood the economy with money by printing new notes,

in order to increase the supply of money. The idea is to add more moneyinto the system to avert deflation and encourage banks/people to borrow and spend.

Quota A quota imposes a physical limit on the quantity of a good that can be imported into a country in a given period of time.

Real disposable Income after taxes and benefits, adjusted for the effects of inflation.incomeReal income Nominal income adjusted for the effects of price changes (inflation)

and expressed at constant prices.Real interest rate The nominal rate of interest adjusted for inflation.Real wage The nominal wage adjusted for the effects of inflation.Recession A period of at least six months when an economy suffers a fall in output.Redundancy Making someone redundant is to end their employment due to a lack of

work available for them.Remittances Sending of money to people in another country.Repo Rate (policy rate) The official 'base' rate of interest that is set by the Monetary Policy

Committee and which, when changed, sends a signal to the rest of thefinancial markets about a desired change in the direction of other borrowing and savings interest rates. Repo is the rate of interest atwhich the Bank of England is prepared to lend to banks.

Retail Price Index (RPI) The RPI is broadly similar to the CPI but includes mortgage repaymentsand some taxes, and excludes the top 4 per cent of earners. It is used tocalculate increases in wages, state benefits and pensions.

Risk averse Exhibiting a dislike of uncertainty, often seen in a recession.Saving ratio The percentage of disposable income that is saved rather than spent.Slowdown A fall in the rate of growth of an economy but not a full-scale recession.Slump A sustained decrease in real GDP and a persistent rise in unemployment.Soft landing A slowdown in economic activity but which does not result in a recession.Spare capacity When a business is not making full use of its available capacity – there

are spare factors of production including land, labour and capital. Whenan economy has plenty of spare capacity, short run aggregate supplytends to be elastic.

Stagflation A combination of slow economic growth and rising inflation, can lead to stagflation. The most notable recent period of stagflation occurredduring the 1970s, when world oil prices rose dramatically, and UK inflation rose at one point to nearly 30 per cent.

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Sterling exchange The external value of sterling calculated using a weighted index of arate index basket of currencies – the weightings are based on the pattern of trade

between the UK and other countries.Sustainable growth Growth which meets the needs of the present without compromising

the ability of future generations to meet their own needs. Economicgrowth that can continue over the long-term without damage to the environment, or the exhaustion of non-renewable resources.

Target A target is an objective of government policy e.g. low inflationTariff A tax on imported products which may be ad valorem (%) or a specific

tax (a set amount per unit imported). Tight labour market When demand for labour is high and there are shortages of labour.

Businesses may have to offer higher wages to attract and keep theworkers they need.

Time lags The time it takes for one change e.g. a change in interest rates to affectother variables e.g. consumer confidence and spending.

Toxic debt Loans that may not be repaid. They are especially scary because of therisk that one toxic debt may poison other loans that were previously OK.For example, if one home loan on one street goes bad, it might makepeople think that all the loans on the street will go bad.

Trade deficit A trade deficit occurs when a country imports a greater value of goodsand services than it exports.

Trade-off A trade-off implies that choices have to be made between different objectives of economic policy.

Tragedy of the A conflict over finite resources between individual interests and the Commons common good which can lead to irreversible damage to the stock of

natural resources available to current and future generations.Transmission How a change in interest rates affects the various sectors of the economy.mechanismTrend growth The long run average growth rate – mainly determined by changes in

the stock of available factor inputs and also improvements in productivity.Trough The low point of the economic cycle beyond which a recovery starts.Under-employment When people want to work full time but find that they can only get

part-time work – the result is a loss of hours that the economy can use.Unemployment trap Disincentive effect if people are better off on benefits than working.Unit wage costs Labour costs per unit of output.Unsecured credit Credit not secured by another asset – i.e. money borrowed on credit

cards.Wage price spiral A situation where workers bid for higher wages because they have seen

their real income eroded by rising prices. This can lead to a further burstof cost-push inflation in an economy.

Wealth effect The supposed link between changes in wealth and household spending.World Bank Owned by 186 member countries, the World Bank is a source of

financial and technical assistance to developing countries. It can provide loans and grants for a wide array of purposes that include investments in education, health, public administration, infrastructure, financial and private sector development, agriculture and environmentaland natural resource management.

World Trade The WTO oversees trade agreements, negotiations and disputes Organisation between member countries.

Notes

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AS Economics Workbook April 2010 - Y12

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