Equilibrium =
When in an economy injections equal its withdrawals.
The Accelerator =
- Injections lead to increased demand.
- This leads to increased supply, or if supply is not available increased prices.
- increased demand and supply, leads to new investments, which are further injections, which leads to an increase in national income.
So growth stimulates more growth. Growth usually accelerates.
The multiplier effect =
New injections spent into the economy get re-spent by those who get paid and re-spent again. So £20m investment by the government can lead to £50m being spent into the economy.
Calculate the multiplier K:
K = 1 / 1 - MPC
Marginal propensity to consume = change in consumption / change in income
Why do we want to know the multiplier:
- decide on the correct level of stimulus
- it can help to control high inflation
Trade Cycle:
- there is a downturn nearly every decade.
- Boom, Recession, Depression, Recovery
Boom =
- low unemployment
- labour and capacity become fully utilised
- leads sometimes to a government budget surplus
- high expectations
- inflation
- imports may rise - money starts to leave the flow
- bottlenecks and shortages may occur
Government policy:
- there is a growing aggregate demand
- raising taxation
- reduce public spending and injections
Recession:
- demand starts to level off because of rising prices
- decrease in investments and expenditures
- decrease in revenues and profitability
- unemployment may rise
- inflation falls
- confidence falls
Government policy:
- lower taxation
- lower interest rates
- increasing public expenditure
- supply-side policy - can take long to take effect.
If the above does not increase demand, this leads to depression
Depression
- high unemployment
- low inflation
- low confidence
- very low demand
- low profits and low revenue
Government policy:
- lowering taxation
- lowering interest rates
- increase public expenditure
- supply-side policy
Recovery:
- confidence grows
- output and employment increase
- demand stabilises or grows
- unemployment falls
- rise in investment
Government policy:
- fiscal policy
- monetary policy
- supply-side policy
Full employment =
Everyone who wants to be in work is in work
How to measure unemployment:
Number unemployed / total workforce x 100%
Why is unemployment a problem:
- potentially increased crime
- long term loss of labour and skills
- output of the economy is below full capacity
- a possible negative effect on national income; wages fall, because of the excessive supply of workforce available
- increased welfare costs
- fall in tax revenue
7 types of unemployment
- Cyclical; during recession or depression people get made redundant
- Structural; closing of the coal mines
- frictional; people who are in between jobs and looking for something else
- seasonal; tourism, farming
- voluntary; as a choice
- classical or real wage: when businesses don’t employ, because wages are too high
- technological: workers displaced because of new technology
Inflation =
The general rising of prices over time.
It’s also a decline in the purchasing power of money.
How to measure inflation:
- RPI (retail prices index), includes the direct and associated costs of housing
- CPI (consumer prices index), housing costs not included (measured in the same way in Europe)
Why is inflation a problem?
- People’s standard of living may fall
- investments tend to stall, because inflation creates uncertainty
- inflation may affect savings
- affect on a country’s trading performance
Types of inflation:
- Demand pull; when demand rises leads to higher prices.
Aggregate Demand > Aggregate Supply = Inflationary gap - Cost push; costs rise and people put their prices up to continue to make a profit
Why do costs rise: - indirect taxes
- raw materials (movement in exchange rate)
- shortages
- Stagflation = combination of a recession and inflation
- wage price spiral: inflation may rise if employers keep on putting wages up, so employees can pay for rising prices
Capital goods:
- Buildings and machinery for example
- very sensitive to the trade cycle
Necessities:
- milk, sugar, bread
- not sensitive to the trade cycle
Non-essentials:
- clothes, cars, luxury food items.
- sensitive to the trade cycle
Goods sold to the public sector
- dependent on government spending
