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A Level Economics Aqa Unit 4 Notes

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Economics Unit 4 Notes Short­hand glossary:

SOL = standards of living GDP = Gross domestic product LRAS = Long run aggregate supply SRAS = Short run aggregate supply UE = unemployment LR/LT = Long­run/long­term SR/ST = short­run/short­term AD = aggregate demand GVT = government IR = interest rates SSPs = supply side policies

The UK Economy ­ Current Stats and Info: Growth and productivity:

• Recovery from great recession one of the slowest, real GDP/capita still 5% below pre­crisis peak + real GDP/capita approx 15­20% below where it should have
been if pre­crisis LR trend continued

• But economic growth now picking up, forecast to be 2.4% in 2015

• Poor UK productivity performance since the crisis, with productivity stagnant as
opposed to usual steady increase year­on­year Employment:

• Unemployment has fallen from 8.5% in 2011 to 5.5% in March 2014

• Good employment performance since crash due to flexible labour markets, with
real wages falling + adjusting instead of mass unemployment, % UK has,
according to the global competitiveness index, the 5th most efficient labour
markets in the world Inflation:

• Inflation fell from 2.8% in 2013 to 1.7% in 2014 and UK slipped into negative
inflation/deflation in 2015 for the first time in decades, due to the effects of lower
world oil prices, which have fallen from over $100/barrel in spring 2014 to under
$50 at the start of 2015 (although now edging up to $55 territory)

• BUT, core inflation at 0.8% (most recently), suggesting that even underlying UK
inflation remains low, although the Bank of England expects strong economic
growth to filter through to pay packets, and wage inflation to pick up, putting
upward pressure on prices across the economy

• Inflation has been more than 1% away from the 2% target in 25 out of the 57
months since May 2010

• House price inflation across the country has continued to outstrip CPI inflation
considerably, reflecting a housing shortage, + leading to problems with labour
immobility as many find it to expensive to move to the more prosperous SE or
London. Balance of payments + exchange rate:

• Worsening current account deficit in recent years, mainly due to a large fall in net investment income, most of which is due to a large­scale selling of overseas
British assets as well as weak global economic conditions

• Pound depreciated approx. 20­25% 2008­9, but has since slowly appreciated GVT policy/data:

• GVT budget deficit as a % of GDP has halved, from 11% in 2010 to 5.7% in 2014

• National debt at 79% of GDP in 2014

• Conservative fiscal plans include further cuts to public spending in the next
parliament, aiming to reach an overall budget surplus by the end of the
parliament

• Tax cuts planned too, with further rises in the personal allowance, tax on savings
interest abolished for 95% of people, and the 40% tax threshold raised

• Interest rates have remained at 0.5% with £375 of QE in total as a more
unconventional monetary tool Other:

UK overall competitiveness ranking = 9 UK ranking for technological readiness = 2 UK youth unemployment 16% in January 2015 UK Gini coefficient is 0.36­0.37

Economic growth, development and living standards:

• Economic growth (LR) ­ An increase, over time, in the potential output of the
economy as represented by an outward shift of the PPF curve

• Short­run economic growth ­ Increase in output/GDP that results from the use
of spare capacity and unemployed labour

• Long­run economic growth is caused by supply­side factors that increase the
total quantity of resources, or increase the efficiency with which we use current
resources, or both

• This comes from increased productivity (labour productivity and in LR total factor
productivity) due to capital accumulation + investment, technical progress +
technological change, education, training

• Productivity ­ Output per worker

• Economic cycle ­ Short­term fluctuations in output around the LR trend rate of
growth (AVG growth rate over time). Boom to downturn to recession to recovery
to boom etc Theories/determinants of LT economic growth:

• Growth in physical capital stock, leading to rise capital/worker + rising
productivity (which may in turn depend on the level of national saving)

• Growth in size of labour force

• Growth in quality of human capital from better education, etc

• Technical changes + technological progress, new innovations + inventions

• Institutions, EG rule of law, enforced property rights + contracts etc

• Increasing productivity, education + technical change important, not just higher
capital investment, as capital investment likely to suffer from diminishing returns Characteristics of a boom (recession will just be the opposite):

• Real GDP grows faster than trend growth

• Likely to lead to demand­pull inflation as businesses hit capacity constraints + so
instead raise prices

• Accelerator theory ­ Higher national income may lead to proportionately greater
investment, as firms expand their capacity to meet future demand too (if they
think it's sustainable)

• Fast consumption growth, with rising real incomes + rising levels of consumer +
business confidence

• Falling unemployment

• Falling no.business failures + rising no.new businesses

• GVT 'fiscal dividend' from higher tax revenues

• +ve output gap Explanations of the business/economic cycle:

• Keynes' explanation ­ 'Animal spirits' + confidence ­ 'pessimism/optimism' ­ lead to fluctuations in AD. As business confidence rises/falls, investment changes
disproportionately largely + is very volatile, leading to the economic cycle.

• Real business cycle theory (BCT) ­ Theory that supply­shocks and supply­side
changes can drive the business cycle. Changes in rate of innovation, technical
progress, oil prices, or other 'real/supply side' shocks could cause economic
fluctuations.

• Austrian BCT ­ Expansion of credit + loose/easy money w/too low interest rates
leads to over­investment + speculation. Eventually, reality hits, malinvestments
become clear as not profitable without artificially low interest rates. Speculative
bubbles burst. AD falls. Root of the recession is the preceding boom, and the
overly loose monetary policy.

• Political BCT ­ Short electoral cycles + incentives politicians face in Western
democracies lead to 'bribing' of voters + giveaway budgets before elections +
cutbacks after to pay for the preceding binge. Less relevant now due to the
diminished role of fiscal policy + independent monetary policy. More technocratic than democratic in economic policy.

• Economic shocks can be endogenous or exogenous (i.e. internal events within
the economic system, OR external 'shocks' from beyond the economic system)

• Economic cycle + SR changes in economic growth driven by ST shocks, demand
+ supply

Measuring economic welfare/standards of living:

• GDP alone is not always a very good measure of standards of living, or economic welfare

• Real GDP per capita should be used to take into account inflation + population
size, to give a more accurate picture. IE, while China's GDP is huge, its real
GDP per capita is far lower due to its very big population

• RGDP/Capita doesn't take into account distribution of income, so might not
accurately reflect the true living standards of the majority of the population,
especially in very unequal societies where income is concentrated at the top.

• GDP doesn't measure non­monetised activity, such as volunteering, housework,
DIY, which is still valuable activity

• GDP omits the hidden economy, which includes illegal activity (drugs, prostitution etc) but, more commonly, informal cash transactions which go unregistered.
Hidden economy approx. 10% of UK GDP but more like 20% in somewhere like
Greece.

• RGDP/C doesn't take into account the changing quality of goods and services, so quality­adjusted GDP may be even higher. EG, the price of phones/computers
has been falling over time, which would lead to lower GDP, but quality and
processing power has hugely increased at the same time.

• Externalities, EG pollution or congestion, not taken into account, by their very
nature they are outside the market

• Difficult to compare between countries if different statistical methods used, if
different quality of data available, especially when looking at developing/LEDC
economies with poor data

• Comparison difficult as Spanish GDP may be lower due to less money spent on
heating, but standards of living are not lower just because of that, and might even be better due to nice weather and more sunshine

• BUT, RGDP/C a simple, objective + universally understood measure, not loaded
with any normative value judgements, which other broader measures of
economic welfare inevitably are

• ALSO, doesn't directly account for non­monetary factors of standards of living,
but a v.good proxy measure as higher income allows more education, leisure
time etc to be afforded + high correlation between increasing incomes +
increasing life expectancy, literacy rates etc

• Growth may be unsustainable + harming future generations Alternative measures of economic welfare/standards of living:

• HDI (Human Development Index) an alternative measure which weights equally income (RGDP/C), health (life expectancy at birth) and education (mean years of
schooling)

• Broader measure may more accurately capture SOL

• But no big improvement on income, as income, health and education normally go hand in hand, as higher real incomes allow society to spend more on health,
education etc, and there's a very large correlation

• BUT, for some countries, HDI a much better measure, EG Qatar with gross
inequality so big discrepancy between AVG incomes and + education + health
outcomes due to the high concentration of wealth + income in the ruling elite

• HDI can also be adjusted for inequality + gender inequality too, but this clearly
involves further subjective, normative value judgements, as not everyone agrees
that income inequality, per se, is bad

• Other measures like a happiness index might also be used, or even broader
measures taking account of many things, to try and measure quality of life more
accurately

• BUT, the broader + more precise you try to be, the more value judgements are
brought in + it's hard to be precise with a necessarily imprecise concept such as
'welfare' of 'happiness' Costs and benefits of economic growth: Benefits:

• Increased standards of living + economic welfare, EG economic growth in China
in recent decades has led to huge declines in poverty + improvements in
standards of living

• Higher real incomes can be used to improve environment, or boost health care
provisions, or fight crime etc, can money improves non­monetary aspects of life
when real incomes rise

• Increased life expectancy

• Reduces poverty + hardship + suffering

• Increased tax revenues mean GVT can help the poor more, or spend more on
defence, education, social programmes, there's a 'fiscal dividend' to economic
growth

• Growth is often self­sustaining, as increasing real incomes boosts consumption,
which leads businesses to increase investment by an ever larger amount,
through the accelerator effect, which boosts LRAS etc

• Allows increased consumption, can buy more luxury items to improve quality of
life, or can 'buy' time + spend more time with family + friends Costs:

• Uses up finite resources, and harms future generations

• Leads to pollution + environmental damage due to the 'tragedy of the commons'
that leads to resources that are commonly owned, EG the environment, to be
over­used + over­exploited + damaged

• Other negative externalities, such as noise pollution or increased stress

• Destroys local communities + cultures AD/AS model:

• AD = C + I + G + (X­M)

• Aggregate demand ­ Total planned spending on goods and services within the
economy in a particular time period at different price levels

• AD curve slopes downwards because:

• Wealth effect ­ Decrease in the price level increased people's real money
balances, which makes people feel wealthier, so spend more

• Interest rates ­ Decrease in price level, so real money balances increase, so real money supply increases, relative to the demand to hold real money
balances. Interest rate is price of money, so increased real supply relative to demand leads to falling interest rates, which increase consumption +
investment + therefore AD.

• Competitiveness ­ Domestic price level falls, increasing competitiveness
relative to other countries, so demand for exports increases, so AD increases

• SR Aggregate supply ­ Quantities of real output businesses plan to produce and sell at different price levels

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