macroeconomics - baffled beewhat is it? • macroeconomics considers the economy as a whole – this...

Macroeconomics

A Level

Year 13

Assessment

National & International Economy

4.2.1 The measurement of macroeconomic performance

4.2.2 How the macroeconomy works: the circular flow of income, AD/AS analysis and related concepts

4.2.3 Economic performance

4.2.4 Financial markets and monetary policy

4.2.5 Fiscal policy and supply-side policies

4.2.6 The international economy

What is it?

• Macroeconomics considers the economy as a whole – this is the total amount of different goods and services produced by all businesses and the government sector

• Key performance indicators

• Objectives

• Policy instruments

What are objectives and instruments?

• Objectives are the aims or goals of government policy

• Instruments are the means by which these aims might be achieved

UK Macroeconomic Policy Objectives

• Stable low inflation (Inflation – 2%)

• Sustainable growth (GDP)

• Improvements in productivity

• High employment (Low unemployment)

• Rising living standards

• Financial stability (Balanced budget)

• Trade (Balance of payments)

Policy Instruments

• Monetary policy –changes to interest rates, the money supply, access to credit and also changes to the value of the exchange rate

• Fiscal policy – changes to government taxation, spending and borrowing

• Supply-side policies designed to make markets work more efficiently

What sectors make up an economy?

1. Households

2. Firms

3. Government

4. International

The Circular Flow of Income

The interdependence of goods markets and factor markets

A recap

FIRMS (suppliers of goods and services, demanders of factor services)

HOUSEHOLDS (demanders of goods and services,

suppliers of factor services)

The interdependence of goods and factor markets

Q1

P1

QF2

PF2

Q2

P2 PF1

QF1

D2 D2

The interdependence of goods and factor markets

P

Q

P

Q

£ £

£ £

Factor services

Goods

Goods Factor services

S S

D1 D1

(1) Consumer demand

(4) Factor supply

(3) Factor demand

(2) Producer supply

O O

Multiplier effect

The circular flow of income

Consumption, injections, withdrawals and equilibrium

Factor payments

Consumption of domestically

produced goods and services (Cd)

The circular flow of income

Firms

Households

Factor payments

Consumption of domestically

produced goods and services (Cd)

Investment (I)

Government expenditure (G)

Export expenditure (X)

BANKS, etc

Net saving (S)

GOV.

Net taxes (T)

ABROAD

Import expenditure (M)

The circular flow of income

WITHDRAWALS

INJECTIONS

Key terms…

Injections = I + G + X

Withdrawals = S + T + M

The Multiplier

Definition

Example

Calculation

The Multiplier

The multiplier effect refers to the increase in final income arising from any new injection of spending. The size of the multiplier depends upon household's marginal decisions to spend, called the marginal propensity to consume (mpc), or to save, called the marginal propensity to save (mps).

The Multiplier

Formula

mpc = marginal propensity to consume

mpw = marginal propensity to withdraw

mps = marginal propensity to save

The mpc + mps = 1

The Multiplier

Example

If consumers save 20p in every additional £, they must consume 80p of that £.

Therefore £1 – 80p = 20p; 1 ÷ 0.20 = 5

This gives a multiplier of 5, so an injection of £100 would increase GDP by £500

The Multiplier

Task

1. Suppose a £100 increase in desired investment spending ultimately results in a £300 increase in real GDP. What is the size of the multiplier?

2. If the MPS is .4, what is the multiplier?

3. If the MPC is .75, what is the multiplier?

4. Suppose investment spending initially increases by £50 billion in an economy whose MPC is 2/3, By how much will this ultimately change real GDP?

The Multiplier

Answers

• The multiplier is defined as the ratio of the change in real GDP to the initial change in spending that brought it about. In this case, the multiplier is £300/£100 = 3.

• The multiplier is 1/MPS = 1/0.4 = 2.5, in this example.

• As the MPS and the MPC sum to one, the multiplier can also be computed as 1/(1 – MPC) = 1/(1 – 0.75) = 1/0.25 = 4.

• The multiplier in this example is 1/(1 – 2/3) = 3. The ultimate change in GDP is 3 x $50 = $150 billion.

4.2.1 The measurement of macroeconomic performance

The Economic Cycle and Economic Growth

Cycles

• Peak, boom, overheating

• Downturn

• Recession, depression, trough, slump

• Recovery, expansion

Cycles Business cycle/trade cycle/economic cycle

Kondratiev K-wave

Kuznets Building cycle

Kitchin Inventory cycle

Keynes Multiplier – accelerator

Schumpeter Technology/innovation

Friedman Monetary

Output Gaps

• The difference between actual growth and the trend rate of growth

• Where would these be on your chart?

• Output lost in a recession is regained in a boom but….

Hysteresis

• The trend rate of growth can shift downwards if there is a deep recession due to permanent losses of human and physical capital

• Loss of skills – structural change • Long term unemployed • Cut backs in investment • Outdated technology • ‘potential’ falls

Hysteresis and Growth Trend

Shocks

Business cycle models

Shocks – Demand or supply side

• Exogenous shocks

• Endogenous shocks

Shocks

• In economics, a shock is an unexpected or unpredictable event that affects an economy, either positively or negatively. Technically, it refers to an unpredictable change in exogenous factors — that is, factors unexplained by economics — which may influence endogenous economic variables.

Worksheet

Which are demand side and which are supply side shocks?

• Explain how a major world recession, an exogenous shock to the UK economy, could trigger a business cycle.

(9/15 marks)

Shocks and ADAS

• Key terms – Long-term growth rate

– Actual growth

– Potential growth

– Trend rate of economic growth

Actual and Potential Growth

• AB to CD shows potential growth

• A to C or A to B shows actual growth

• You can have an increase in potential growth without having actual growth

Task

Using a PPF diagram, show the following

1. An economy with full employment experiencing economic

growth

2. An economy initially with full employment experiencing a recession, keeping its AS capacity constant

3. An economy in recession returning to full employment, with its AS capacity constant

4. An economy which initially has a small and constant output gap, experiencing economic growth

ADAS

A negative demand side shock

General

Price

Level

National Income

AD1

SRAS

Pe

Ye

LRAS

Yfc

AD2

Y2

P2

Caused by?

Effect on?

• PPF

• Unemployment

• GDP

• Inflation

A positive demand side shock

1. Finish it off

2. Cause?

3. Impact upon

a. GDP

b. PPF

c. Inflation

d. Unemployment

A positive demand side shock

General

Price

Level

National

Income

AD1

SRAS1

P1

Y1

LRAS = potential GDP

Yfc

P2

Y2

AD2

Supply side shocks

• Show the effect on an ADAS diagram of the following – Increased rates of emigration

– A fall in international commodity prices

Supply side shocks General

Price Level

National Income

AD

SRAS1

P1

Y1

LRAS

Yfc

SRAS2

P2

Y2

SRAS3

Y3

Where is the growth going to come from?

Causes of economic growth

• Economic stability and sound macroeconomic policies

• Increased labour activity/participation

• Increased labour productivity

• Investment in physical capital

• Improved human capital

• Enterprise

One-to-One

• Divide the class into two halves • One half of the class study ‘costs of

economic growth’, the other half the ‘benefits’

• Prepare a teaching aid, you can collaborate with your half, this must be on A3

• At the end of your preparation you must teach the other half

Is growth good?

• Advantages

• Improvements in living standards: More jobs:

• The accelerator effect of growth on capital investment:

• Greater business confidence:

• The “fiscal dividend”:

• Potential environmental benefits

• Benefits from growth driven by technological change

• Disadvantages • Inflation

• Environmental concerns

• Inequality

Class question

• Why are demand side policies thought to be ineffective in raising Britain’s long-term rate of economic growth?

Classroom questions

1. Outline two problems that occur when using national income or GDP as a measure

2.Distinguish between narrow and broad definitions of standards of living.

3.What is meant by sustainable economic growth?

4.How is the United Nations Human Development Index (HDI) constructed

5.Should Economics ‘wellbeing’ be used a government target instead of GDP

Key terms tests • Aggregate supply

shock

• Animal spirits

• Business confidence

• Capacity

• Consumer confidence

• Credit crunch

• Depression

• Double dip recession

• Economic shocks

• Full capacity output

• Innovation

• Non-inflationary growth

• Paradox of thrift

• Potential output

Kuznets curve - explain

What would the question be?

What would the question be?

Applied Economics

The Impact on the economy

Macroeconomic Indicators

Uses of National Income Data

Terms - explain

1. Gross Domestic Product (GDP) 2. Gross National Product (GNP) 3. National Income (NI) 4. Non-monetised sector 5. Purchasing Power Parity (PPP) 6. Human Development Index (HDI) 7. Human Poverty Index (HPI) 8. Measure of Domestic Progress (MDP) 9. Misery Index

Problems with the data

• GDP does not fully measure output – Non-monetised sector

• Unpaid labour

• DIY

• Parenting

• ‘black’ economy

• GDP does not account for quality

• BBC-B Computer

• £400 (£1200)

• I-pad

• £329

Problem with the data

• Distribution of income

• Value of Leisure

• Externalities

• What is produced – Defence or consumer goods?

• Differences between countries – PPP

– How accurately is the data collected?

Alternatives in measuring welfare (you need to know at least one of these!)

• HDI – Standard of living (GDP per capita)

– Life expectancy at birth, in years

– Educational attainment (literacy and enrolment)

– Maximum value =1, the closer the better.

– Use ‘The Economist in Figures’ to research countries which differ in ‘performance’

– Can you explain why they differ?

Alternatives in measuring welfare

• HPI – Longevity

– Knowledge

– Economic provision

– Social inclusion

Alternatives in measuring welfare

• MDP – Social and environmental cost of growth

• Crime

• Family breakdown

– Benefits of unpaid work • household labour

Alternatives in measuring welfare

• Misery Index – Adding the unemployment rate to the rate

of inflation

– High unemployment and high inflation = higher economic and social costs

World Happiness Report (WHR)

• GDP per capita

• Social support

• Healthy life expectancy

• Freedom to make life choices

• Generosity

• Truth or absence from corruption

Sustainable Economic Growth

• You need to know the issues – Resource depletion

• Market mechanism – Higher prices

– Greater efficiency in use

– Greater supply (cost effective to research)

– Investment in substitutes

– Environmental damage

– Global warming • Koyoto Protocol 1997; World Summit 2015

• Developing countries exempt (China, India, USA!)

Index of Sustainable Economic Welfare

• ISEW = personal consumption + public non-defensive expenditures - private defensive expenditures + capital formation + services from domestic labour - costs of environmental degradation - depreciation of natural capital

A recent EU survey reported that income per head was significantly lower in Greece and Portugal than in the Netherlands and Ireland. Evaluate the view that living standards must therefore be higher than those in Greece and Portugal (25 marks)

• Take the exemplar answer and assessment sheet.

• What level do you think best describes your answer? Why? (write it on the assessment sheet)

• Identify what you could include to improve your answer. (write it on the assessment sheet)

• Add a paragraph (diagram) to your answer to improve it. What level is it now?

In Pairs

Explain the term world recession and analyse how both trade and investment can help to bring about economic growth.

(10 marks, Jun10)

Diagrams

• Illustrate an increase in SRAS and LRAS

• Illustrate short-term and long-term economic growth on a PPF diagram.

Fiscal Policy

A2 Developments

1. Taxation

Objectives of the UK tax system

1. Funding government spending

2. Managing the economy as a whole

3. Redistribution of income

4. Correcting market failure

Taxation

• Direct – Tax liability cannot

be passed on to someone else

• Indirect – Depending on

elasticity the ‘burden’ of tax can shift

Principles of taxation

Adam Smith’s “Canons of taxation” (or what makes a good tax)

1. Economical

2. Equitable

3. Convenient

4. Certain

5. Efficient

6. Flexible

Evaluation of indirect tax

• Arguments for • Arguments against

Automatic stabilisers

• Government spending and taxation are both automatic stabilisers

• Video

• e.g. 1 Unemployment leads to increased government spending (benefits) so incomes don’t fall as much. Therefore AD doesn’t fall as much. It stabilises the economy.

• e.g. 2 In a boom unemployment falls and leads to reduced government spending (benefits) and higher tax rates so incomes don’t rise as much. Therefore AD doesn’t rise as much. It stabilises the economy.

Progressive, regressive or proportional?

• Progressive

– The proportion paid increases as income increases

– The marginal rate is higher than the average rate

• Regressive

– The proportion of tax paid falls as income rises

– The marginal rate is less than the average rate

• Proportional

– The proportion of tax paid stays the same as income rises

– ‘a flat tax’ marginal rate is the same as the average rate

Fiscal stance

• Expansionary • Contractionary (deflationary)

… or neutral

• Explain how fiscal policy might be used to bring about supply-side improvements to an economy (15 marks)

• The impact of fiscal policy on the economy

• Crowding out

• Liquidity trap

Fiscal Policy

Summary

(if it looks like hard work, it probably is)

‘Excuse me Mr Nolan, my brain is full’. ‘Ok Josh’.

1. Discuss the issue of the budget balance a. What does this mean? b. Will there always be a balanced budget? c. What might cause an imbalance?

2. Evaluate the possible economic consequences of a budget deficit and corrective measures a. What could cause a deficit and how might a government solve this? b. How does this link to the business cycle? c. How does this link to the circular flow of income?

3. Evaluate the possible economic consequences of a budget surplus and corrective measures a. What could cause a surplus and how might a government react to this? b. How does this link to the business cycle? c. How does this link to the circular flow of income?

4. Assess the economic significance of changes in the level and distribution of public expenditure. a. On capital expenditure and current expenditure

5. Analyse and evaluate the microeconomic significance of taxation and the various roles and relative merits of the different UK taxes.

a. Which are progressive, regressive and proportional? b. How do changes in these impact on consumers, businesses and the macroeconomic objectives of

government 6. Awareness of the principles of taxation which are likely to underlie a taxation system, such as the

ability to pay and the impact on incentives. a. Are these different taxes compatible with Adam Smiths canons of taxation?

7. There should be an awareness of the Stability and Growth Pact within the euro area. a. What does this mean?

8. Explain the workings of automatic stabilizers a. Both in terms of a boom and a recession b. The impact on a budget surplus/deficit and circular flow of income

“in this world nothing can be said to be certain, except death and taxes.” Benjamin Franklin

The Laffer Curve

• Video

Laffer curve

• Arthur Laffer – the ‘Father of supply-side economics’

• High tax rates are a disincentive to work – Causes national income to fall, and

– Tax revenue falls

Supply-Side Policies

Aims of supply-side policies

• Shift LRAS to the right

• Expanding the economy (output)

• Non-inflationary

• Mainly fiscal policies and micro

• Labour market measures

• Product market measures

Labour market measures

• Lower (marginal) rates of income tax

• Raise tax thresholds

• Raise personal allowances – These increase the incentive to work

• Reducing state benefits – Or make them more difficult to claim

• ‘New deal’, ‘Welfare to work’ – Increase participation through

• WFTC (working families tax credits) • Minimum wage

• Education and training – EMA (educational maintenance allowance?) – Raise compulsory school leaving age

• Trade Union reforms – Reduces labour costs – Increases international competitiveness – Increases labour flexibility

Product Market Measures

• Designed to increase competition and efficiency

• Privatisation • Deregulation • Tougher competition policy (reduce market

power) • Encourage entrepreneurship

– Tax concessions – Regional policy assistance – Loan guarantee schemes

What will successful supply-side policies look like?

ADAS PPF

Are taxes equitable?

When looking at tax "fairness", we typically look at two different goals in distributions to look at equity; vertical and horizontal equity.

Horizontal Equity

• This principle claims that there is "equal treatment of equals." In other words, individuals who have the same income, should face the same tax rate.

Vertical Equity

• This principle claims that wealthier people, or those with access to more resources, should pay higher taxes.

Example

The Poll Tax is an example of a tax that has horizontal equity (everyone pays a lump sum of £500 a year). Mrs Thatcher’s theory was that since everyone had the same access to council services everyone should pay the same tax.

However, the poll tax does not meet the criteria for vertical equity. For those on low incomes, the poll tax was a high % of their disposable income. For those on high incomes and more ability to pay it was a low %.

Terminology

• Direct tax

• Indirect tax

• Canons of taxation

• Horizontal equity

• Vertical equity

• Hypothecation

• Benefit principle

• Progressive

• Regressive

• Proportional

2. Government expenditure

Main areas

1. Capital expenditure

2. Current expenditure

3. Transfer payments

• Capital expenditure is spending on assets. It is the purchase of items that will last and will be used time and time again in the provision of a good or service.

• new hospital

• new computer equipment or networks, building new roads etc.

• Current expenditure is spending on items that are consumed and only last a limited period of time. They are items that are used up in the process of providing a good or service.

• wages and salaries

• consumables - stationery, drugs for health service, bandages etc.

• For each of the points on the ppf, give some information about the state of the economy, the possible causes and implications

The balanced budget

Three possible budgetary positions are

1. G=T (balanced budget)

2. G>T (budget deficit)

3. G<T (budget surplus)

The aim of the lesson

• Candidates should be able to use macroeconomic models, including the AD/AS model, to analyse the causes of possible conflicts between policy objectives in the short run and long run.

• They should be able to discuss approaches to reconciling these conflicts and the monetarist/supply-side view that the major macroeconomic objectives are compatible in the long run.

Diamond 9 • Put the following into a diamond formation based on the

most important objective at the top and least at the bottom

1. GDP -0.2%

2. UK families are typically £7,900 in debt

3. Trade deficit £7.1bn

4. Inflation 3.6%

5. Unemployment 8.6%, 2.67m

6. The current weakening of the Pound

7. House prices falling

8. Global warming

9. UK Public sector debt £1tn

Macroeconomic Conflicts

• Using your diamond 9 now come up with as many potential economic conflicts

Solutions to Macroeconomic Conflicts

• Pass your list to another group

• Choose the most important 3 and come up with potential solutions

• Discuss ways in which government economic policies can be used to try to reconcile conflicts between macroeconomic objectives. (25 marks, Jan11)

Macroeconomic Indicators

Inflation and Deflation

Inflation

Key terms

• Inflation • Deflation • CPI • Family Expenditure Survey • Cost-push inflation • Demand-pull inflation • Wage-price spiral • Anticipated inflation • Unanticipated inflation • Shoe-leather costs • Benign deflation • Malevolent deflation

Inflation

• Retail Price Index (RPI)

• Consumer Price Index (CPI) – Weighted price index

• Relative importance as proportion of spending

• Price index X weighting = weighted price index

Limitations of CPI

• Different population groups experience different inflation. Not everyone is ‘average’.

• House prices not included but mortgage repayments influence spending.

• Over-estimate inflation. Prices may not reflect quality/innovations

Cost Push revisited

• Causes – Import costs

– Labour costs

– Indirect tax rises

– Wage-price spirals

Demand Pull revisited

Quantity Theory of Money (Monetarists)

• That an increase in the money supply will lead to an increase in the price level – Fischer equation – Equation of exchange

• M x V = P x T (or MV = PY) • M = Money supply • V = the velocity of circulation • P = general price level • T = Transactions (output) • Y = RNO (real GDP)

• Velocity of circulation – The number of times a unit of currency

changes hands in a year (to buy goods and services)

– This is assumed to be constant – T and Y tend to increase slowly over time,

therefore are also assumed to be constant – M x V = P x T if V and T (Y) are constant, a

change in M will cause a change in P – inflation!

Consequences of Inflation

• Competitiveness • Investment • Distribution of income • Industrial relations • Fiscal drag • Hyperinflation • Money illusion • Menu costs • Shoe-leather costs

Inflation and Index numbers

Note the micro overlap

Add the definitions for extra

marks

Include a diagram for extra marks

Macroeconomic Indicators

Unemployment and Inflation

The Phillips curve

NAIRU

EAPC

Areas covered

Types of Unemployment

• Quick recap – Frictional

– Structural

– Seasonal

– Demand deficient (Keynesian)

– Technological

Short run and long run unemployment:

• Classical theory – – short run unemployment is a temporary

phenomenon; wages will fall and the labour market will move back into equilibrium

– Long run – unemployment will be ‘voluntary’

Keynesian Unemployment:

• Unemployment in the long run may remain stubbornly high because of imperfections in the market – ‘sticky wages’

Inflation and Unemployment using AS/AD

Inflation

Real National Income

AD1

AS1

2%

U = 4%

Assume the economy has an inflation

rate of 2% and a level of national

income giving an unemployment rate

of 4%. AD rises for some reason.

AD2

U = 3%

3.75%

The rise in AD leads to a fall in

unemployment but inflationary

pressures push inflation up to 3.75%.

Producers try to expand output but at

increased cost – employing more

expensive capital, paying workers more

to do work etc. Increased cost results in

a shift in AS to the left – workers start to

be laid off.

AS2

4.0%

The short run fall in unemployment is only

temporary; as AS shifts, unemployment will

start to rise again and the economy will end

up in the long run in a position with

unemployment at 4% but with higher

inflation. Expansionary fiscal or monetary

policy will only lead to reductions in

unemployment in the short run. In the long

run unemployment will return to its natural

rate. Attempts to reduce unemployment

below the natural rate will be inflationary.

The Phillips Curve

• 1958 – Professor A.W. Phillips • Expressed a statistical relationship

between the rate of growth of money wages and unemployment from 1861 – 1957

• Rate of growth of money wages linked to inflationary pressure

• Led to a theory expressing a trade-off between inflation and unemployment

The Phillips Curve Wage growth % (Inflation)

Unemployment (%)

The Phillips Curve shows an inverse

relationship between inflation and

unemployment. It suggested that if

governments wanted to reduce unemployment

it had to accept higher inflation as a trade-off.

Money illusion – wage rates rising but

individuals not factoring in inflation on real wage

rates.

1.5%

6% 4%

2.5%

PC1

However…..

• 1970s – Inflation and unemployment rising at the same time – stagflation

• Was the Phillips Curve redundant?

• Or was it moving? • http://money.howstuffworks.com/stagflation2.htm

The Phillips Curve (The Monetarist View)

Inflation

Unemployment

Long Run PC

PC1

PC2 PC3

Assume the economy starts with an inflation

rate of 1% but very high unemployment at

7%. Government takes measures to reduce

unemployment by an expansionary fiscal

policy that pushes AD to the right (see the

AD/AS diagram on slide 15)

7%

2.0%

1.0%

There is a short term fall in unemployment but

at a cost of higher inflation. Individuals now

base their wage negotiations on expectations

of higher inflation in the next period. If higher

wages are granted then firms costs rise – they

start to shed labour and unemployment creeps

back up to 7% again.

3.0%

To counter the rise in unemployment,

government once again injects resources into

the economy – the result is a short-term fall in

unemployment but higher inflation. This higher

inflation fuels further expectation of higher

inflation and so the process continues. The long

run Phillips Curve is vertical at the natural rate

of unemployment. This is how monetarist

economists (Milton Friedman) have explained

the movements in the Phillips Curve and it is

termed the Expectations Augmented Phillips

Curve. (EAPC)

• Where the long run Phillips Curve cuts the horizontal axis would be the rate of unemployment at which inflation was constant – the so-called Non-Accelerating Inflation Rate of Unemployment (NAIRU)

To reduce unemployment to below the natural rate would mean:

1. Influencing expectations – persuading individuals that inflation was going to fall

2. Boosting the supply side of the economy - increase capacity (pushing the PC curve outwards)

Supply-side solutions

• Education: – Boosting the number of those staying on at school

• Raising the leaving age

– Boosting numbers going to university • Grants/loans/bursarys

– Lifelong learning

– Vocational education

• Welfare benefits: – The working family tax credit

– Incentives to work

• Labour market flexibility – Relaxation of employment laws

Phillips Curve

Building a diagram

10 steps to Phillips Fulfilment

1. What goes on the vertical axis?

2. What goes on the horizontal axis?

3. What shape is the short run Phillips curve?

Add this to the diagram assuming inflationary expectations are zero

4. Inflationary expectations have increased, where would we put the new short run Phillips curve?

5. Inflationary expectations have increased again, where would we put the new short run Phillips curve?

6. Again, inflationary expectations have raised the curve further. Add this to the diagram

7. Where would we add the long run Phillips curve?

8. What is the long run unemployment rate? Label this A

9. What happens if the government adopts expansionary fiscal policy to reduce unemployment to below OA? Label this Z and inflation 5%

10. If inflationary expectations remain at 5%, what happens in the long run? Label this B.

NAIRU v NRU

• NAIRU = Non accelerating inflation rate of unemployment (equilibrium unemployment; frictional and structural)

• NRU = natural rate of unemployment (voluntary unemployment)

• Can use either

Quick Quiz

Examination questions

a) Explain how a fall in the rate of inflation might be achieved by both

demand-side and supply-side factors (15 marks)

b) Evaluate the possible consequences of a falling rate of inflation for

the performance of the UK economy. (25 marks)

Explain how a fall in the rate of inflation might be achieved by both demand-side and supply-

side factors (15 marks)

• Demand • Supply

Evaluate the possible consequences of a falling rate of inflation for the performance of the UK

economy. (25 marks)

falling rate of inflation

• Low inflation

• Falling inflation

• Deflation

performance of the UK economy

• Economic growth

• Unemployment

• Balance of payments

• (Inflation)

The International Economy

• Globalisation

• Trade

• The Balance of Payments

• Exchange Rate Systems

• The European Union (EU)

Globalisation and Trade

The causes and characteristics Reasons for trade Pattern of trade

Theories and their limitations Why trade is restricted

Task

• You have 5 mins to find as many ‘global’ products as you can.

Product Country of origin

What…….?

…. And where?

What and where?

• http://www.bbc.co.uk/schools/gcsebitesize/geography/globalisation/globalisation_video.shtml

• http://www.guardian.co.uk/world/globalisation

WTO

MNC’s

BRIC’s

Global Village

Protectionism

• The ever increasing integration of the world’s local, regional and national economies into a single international economy

• It is not new

Economic integration

• Free trade in goods and services

• Free movement of labour

• Free movement of capital

• Free interchange of technology and intellectual capital

Causes of globalisation

• Trade in goods

• Trade in services

• Trade liberalisation

• Multinationals

• Financial flows

• Foreign ownership

• Communications and IT

Effects of globalisation

• Prices • Consumer choice • Incomes • Employment (and unemployment) • Income distribution • Environment • Specialisation and economic dependency • Non-economic factors

Research task

• Share you findings with another student

• 3, 2, 1 – 3 important points

– 2 of these which are more significant

– 1 of these which is highly relevant

Why trade?

• Reasons • Implications

Integration

• Widening integration

• Meaning and examples

• Deepening integration

• Meaning and examples

Trade

Trade theories

• Adam Smith • David Ricardo

The game

• Divide yourselves into two teams

• Each team will represent a country, make up a name for your country.

Aims

• How resource endowments can give countries advantages

• The nature and benefits of specialisation

• The benefits to be gained from trade

• The principle of opportunity costs

• The role of power relations in trade

Round One

• You will be given ten minutes to produce as many triangles and stars as possible in this period. You must produce the goods accurately and one at a time - any not conforming to the regulations will not be counted. You will have five minutes to produce stars and five to produce triangles - I will tell you when to swap over production.

• When the ten minutes is up you should record your production levels on the record sheet provided What is the total world output of stars and triangles?

Round Two

• In this round your country will specialise in producing just one commodity. If you are the country with the templates, then you will produce stars whilst the other country will concentrate on just producing triangles.

• At then end of the ten minutes, you will be asked to record your production figures on the record sheet. What is the world production level after specialisation?

Round Three

• You will now have the opportunity to arrange some trade between the two countries in order to get the things you were not producing in Round Two.

• When you trade you will have to negotiate how many stars you are willing to exchange for each triangle and vice versa.

• The rate at which you agree the trade is referred to as your Terms of Trade.

• Record your gains on the record sheet.

Discussion

• The world trading system is obviously much more complex than the game you have played but essentially the issues are the same. Some countries have more and better resources than others but there will be gains from specialisation and trade.

• Where problems arise is in the extent to which each country is

able to negotiate its terms of trade and the nature of the power it is able to exert. For example, the United States as one of the world's most powerful trading nations and economies is likely to be able to negotiate favourable trading terms with a country such as Ethiopia.

• As you go through your discussions, ensure that you make notes

in your second record sheet. This will help to provide you with a useful set of notes on the topics covered.

The game

At the end of the game, students should be able to:

• Explain the principle of absolute advantage • Explain the principle of opportunity cost and

be able to do some basic calculations to work out opportunity cost ratios

• Explain the principle of comparative advantage

• Explain the meaning of 'terms of trade' • Comment on the role of power relations in

trade

Trade (further examples) a self-sufficient economy

Country A Country B Total

Stars 200 160 360

Triangles 200 80 280

1 star = 1 triangle

1 star = 0.5 triangles

Country B has a comparative advantage in

producing stars

Trade (further examples) Specialising in the good with the greatest comparative advantage

Country A Country B Total

Stars 0 320 320

Triangles 400 0 400

Trade (further examples) Partial specialisation creates benefits for both countries

(increase in economic welfare)

Country A Country B Total

Stars 60 320 380

Triangles 340 0 340

Summary

• Countries can still benefit by specialising in the good that it has a comparative advantage in.

• This means the opportunity cost of producing in that country is lower than other countries.

• Should lead to allocative and productive efficiency

• These benefits will be lost if a country tries to become self sufficient

• Without trade economies of scale will not be fully exploited

Terminology

• Absolute advantage – Where a country using a given resource input is

able to produce more than other countries with the same input

• Comparative advantage – Where a country can produce a good with a lower

input cost (opportunity cost) than other counties • Terms of trade

– measures the rate of exchange of one good or service for another when two countries trade with each other.

Trade theories

Adam Smith

Absolute Advantage

David Ricardo

Comparative Advantage

Terms of Trade

index of export prices

TOT = X 100

index of import prices

Protectionism

• Trade restrictions – Infant industry argument

• LEDC’s

– Maintain domestic employment • Immobility of labour

– To prevent ‘dumping’ • China

– To avoid ‘unfair’ competition • Child labour

Harberger Triangles

Protectionist policies

• Tariff

• Quota

• Public sector procurement policies

• Subsidies

• Non-tariff barriers

• Exchange rate (currency restrictions)

June 2012

09

Explain three protectionist policies that a government could introduce to reduce a deficit on the current account of the balance of payments.

(15 marks)

The European Union

• 27 member states

• A common market

• The Euro (Eurozone)

• Customs Union. This is s free trade area with a common external tariff

Community Institutions

• European Commission, this is the civil service of the EU

• Council of Ministers from different countries make decisions on policy

• European Council. Meets twice a year to make decisions which fundamentally alter EU policy

• European Parliament directly elected body of 626 members

• The Court of Justice. Is based in Luxembourg

Treaty of Maastricht 1992

• Economic, social and Political extensions to the EU

• Common foreign and security policy

• Intergovernmental cooperation on justice and home affairs

• ‘Deepening integration’

Single Market. - European Union

This occurs when the member countries act as a single economic area with the free movement of labour and capital

This involves: • No Tariffs on trade between member states • Elimination of border controls • Free movement of People • Mutual recognition of qualifications • Harmonization of taxes and other industrial

and economic laws

Monetary Union

is a single market plus…

• A common currency (Euro)

• No internal exchange Rates

• Common monetary policy (independent central bank)

Obstacles

• Customs Formalities • Different Tax Rates, especially on Alcohol

and tobacco • State Subsidies to domestic industries, or

tax breaks to encourage inward investment. This creates unfair competition within the EU

• Different regulations added to the cost of business

• Different currencies (until the Euro was launched)

Benefits of A Single Market

• Trade Creation. Exploitation of comparative adv allows lower prices and costs. Leading to higher output and more employment

• Reduction in the direct costs of barriers

• Economies of scale from specialization

• Greater competition

Costs of a Single Market

• Structural Change due to increased specialization

• Adverse Regional multiplier effects. The creation of a single market tends to attract capital and jobs away from the periphery areas to the centre.

• Development of Monopoly/ Oligopoly power

• Trade Diversion. If external barriers remain high countries could lose out

Potential new entrants

• Croatia

• Iceland

• Montenegro

• Serbia

• FYR Macedonia

• Turkey

• Albania

• Bosnia Herzegovina

• What are the implications for ‘wider integration’?

Who can join?

• ‘Copenhagen criteria’ – stable institutions guaranteeing democracy,

the rule of law, human rights and respect for and protection of minorities;

– a functioning market economy and the capacity to cope with competition and market forces in the EU.