A2 Economics Macroeconomics Revision Workbook _ April 2010

A2 EconomicsMacroeconomicsRevision Workshop

Student Name

2 A2 ECONOMICS Revision Workshop April 2010

Session 1Globalization: Shifts in GlobalTrade and Investment

Economic growth in a selection of countries 2008 2009 2010

World output 3.0 -0.8 3.9United States 0.4 -2.5 2.7Euro area (16 countries) 0.6 -3.9 1Germany 1.2 -4.8 1.5Japan -1.2 -5.3 1.7United Kingdom 0.5 -4.8 1.3Africa 5.2 1.9 4.3Russia 5.6 -9.0 3.6Developing Asia 7.9 6.5 8.4China 9.6 8.7 10India 7.3 5.6 7.7Brazil 5.1 -0.4 4.7

Source: International Monetary Fund, Economic Outlook, February 2010, 2010 data are IMF forecasts

2009 was a difficult year for the global economy

Making connections –five ways in which the world recession has affected the UK economy

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1 What are the main determinants of foreign investment decisions?

Foreign direct investment in the world economy

Examples of each to use

Access to natural resources

Closeness to growing consumer markets

Access to technology and intellectual property

Efficiency gains from out-sourcing production to lower cost countries

Other factors


Price Level

National Output

LRAS

Y2

AD2

SRAS

Using AD/AS to illustrate some of the gains from inward investment

Possible costs of Foreign Direct Investment

Worker exploitation issues

Doubts over job creation

Environmental aspects

Remittance of profits overseas

Impact on domestic firms

Other disadvantages

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3 The rise of FDI from emerging market countriesHere are some examples of large scale investments made in African countries from the BRICs

2009 Liberia China Mining $2.6 billion FDI

2009 Chad India Textile $25 million Line of credit

2009 S.Tome/Principle India Priority projects in agriculture, $5 million Line of creditcapacity building, infrastructure

2009 S.Tome/Principle India Small and medium enterprises sector $1 million Grant

2009 Mozambique India Rural electricity projects $30 million Line of credit

2009 Nigeria Russia Gas $2.5 billion Investment

2009 Angola Russia Construction $500 million Investment

2009 Angola Russia Telecommunications $328 million Investment

2009 Angola China Oil $1.3 billion Acquisition

2009/13 Nigeria Brazil Oil $2 billion FDI

2009/13 Angola Brazil Oil $800 million FDI

2010 Zimbabwe China Development projects $2.9 million Grant

2010 Zambia China Development projects, Commerce, $1 billion ConcessionalTrade and industry loan

2010 Zambia China Stadium in Ndola $10 million Grant

2010 Malawi India Development projects $50 million Line of credit

2010 Malawi India Earthquake relief and projects $5 million Grants

2010 Zambia India Construction of the Itezhi-Tezhi $50 million Line of creditHydropower project

2010 Zambia India Social sector $75 million Soft loan

2010 Zambia India Health and education $5 million Grant

2010 Tanzania China Infrastructure & ICT sector $180 million Concessionaryloans

2010 Mozambique Brazil Mining $1.3 billion Investment

2 Changing Patterns of FDI FlowsDeveloped countries (MEDCs) still provide the bulk of foreign direct investment flows1 Between developed countries2 From developed to developing / emerging countries

But there is a clear shift in the pattern of FDI. More FDI from emerging economies to lowest income countries (LICs). And also rising FDI from emerging economies to developed nations

• Much of this shift is the result of trade imbalances – e.g. the strong trade surpluses ofcountries such as China, India, Brazil and Russia + the other main oil-exporting nations


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Evaluating benefits & costs of FDI for lowest income countries

Economic advantages

Costs and risks of FDI for the lowest income countries

Exports

Capital

Health

Finance

Environment

Tradedeficit

Capitalflight

Labourmigrants

Roguedonors?

Othercosts


De-globalisation – the return of protectionism

Background notes:

The global financial and economic crisis led to a recession in the worldeconomy in 2009. When individual countries are in economic trouble thelobbying for protectionist policies nearly always gathers momentum andthis has certainly happened in the last two years. Global Trade Alert’s latestreport identifies no fewer than 192 separate protectionist actions since November 2008, with China as the most common target. Russia has introduced the biggest number of protectionist measures since the crisisstarted - and of course Russia is not a member of the WTO so it not boundby any commitment to reduce trade barriers.

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Import TariffsExample

Import QuotasExample

Government SubsidiesExample

Controls on Mergers and TakeoversExample

Immigration RestrictionsExample

Favouring Domestic BusinessesExample

Currency ManipulationExample

Extra BureaucracyExample


Analysis and evaluation of import tariffs

When analysing a tariff try to consider the direct and indirect effects on consumers and producers.And also use economic welfare concepts such as consumer and producer surplus.

Indirect effects of tariff protectionThere are many indirect (or second round) effects of decisions to introduce tariff or other forms of import protection and strong evaluation in an exam answer might focus on some of the followingareas.

Consumers

Domesticproducers

Government

Importers

Price

P1

Output

DomesticSupply

World supplypre-tariff

DomesticDemand

Q2Q1

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EconomicEfficiency

Retaliationby affected

nations

Costs andInflation

Lowerincomegroups

Price

P1

Output

Export supplyof steel (no quota)

Import demandfor steel

Q1

Analysis and evaluation of import quotas


What is dumping?

What are the aims behind dumping?

How might dumping affect a developing economy that alleges dumping by another country?

Anti-Dumping Duties and Developing Countries88 of the 104 anti-dumping cases taken to the World Trade Organisation in the second half of 2009 were brought by developing countries against subsidised imports.

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Currency manipulation

Some countries have been accused of resorting to competitive devaluations in a bid to increasetheir competitiveness in international markets.

Advantages of currency devaluation Risks from deliberate currency devaluation


Session 2 Poverty, Inequality and Unemployment in the World EconomyThe World Bank on poverty“Poverty is hunger. Poverty is lack of shelter. Poverty is being sick and not being able to see a doctor. Poverty is not having access to school and not knowing how to read. Poverty is not havinga job, is fear for the future, living one day at a time. Poverty is losing a child to illness brought aboutby unclean water. Poverty is powerlessness, lack of representation and freedom.”

Evidence on extremepoverty in the world economy

What is the difference between absolute poverty and relative poverty?

What effect has globalization had on the level of poverty?

Poverty is not just about income – which other indicators might be used to measure extremepoverty in the world’s lowest income countries?

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Less than $1.25 a day 1990 2005 2015China 60.2 15.9 5.1India 51.3 41.6 23.6Sub-Saharan Africa 57.6 50.9 38.0Latin America 11.3 8.2 5.0Total 41.7 25.2 15.0

Less than $2.00 a day 1990 2005 2015China 84.6 36.3 16.0India 82.6 75.6 58.3Sub-Saharan Africa 76.2 73.0 59.6Latin America 19.7 16.6 11.1Total 63.2 47.0 33.7

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Relative poverty

Per capita income data is measured in PPP terms – purchasing power parity – and in US dollars. Identify two of the limitations of expressing data in this way

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2

Per Capita Income Statistics (PPP) measured in US dollars 2007 2010 2014

Median $7,417 $7,902 $10,007

Mean $13,074 $13,597 $16,010

Top $85,371 $95,597 $88,779

Bottom* $313 $347 $438

% Top over bottom 27149% 27327% 20162%

Source: IMF World Economic Report October 2009; News N Economics

• Income or wealth compared to other members of society• Gini-coefficient of inequality is the most commonly used measure of inequality• The coefficient varies between 0, which reflects complete equality and 1, which

indicates complete inequality (one person has all the income or consumption, all others have none).

Estimates of Gini coefficients in different countries

Denmark 24.7 Brazil 55.0

Japan 24.9 South Africa 57.8

Sweden 25.0 Bolivia 58.2

Norway 25.8 Colombia 58.5

Czech Republic 25.8 Angola 58.6

Slovakia 25.8 Haiti 59.5

Germany 28.3 Botswana 61.0

Ethiopia 29.8 Namibia 74.3

The Gini index lies between 0 and 100. A value of 0 represents absolute equalityand 100 absolute inequality. Source: World Bank 2009 Development Report.


Determinants of relative poverty in developed and developing countries

The causes of relative poverty are complex and will vary from country to country at different stagesof economic development. Many of these factors can be applied across nations.

The spike in global food prices in 2007-08 was good news for some countries but created hugeproblems for millions of poor consumers in economies across the world. The World Bank calledhigh food and energy price inflation the “silent tsunami” causing many millions of people to experience severe poverty. And then in 2009 came the world recession. In this section we considersome of the effects of the recession on developing countries.

Factors Revision Notes

Wage inequalities

Weaknesses in human capital

Taxation and welfare systems

Effects of high unemployment

Discrimination in the labour market

Debt constraints

Impact of food and energy price inflation

Impact of climate change

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Impact of the world recession on Revision Notes

Foreign direct investment flows

Commodity prices and horticulture exports

Tourism industries

Employment

Income from remittances

Aid receipts

Examples of policies Main aims Examples

Micro Finance programmes

Investment in sustainable energy

Social entrepreneurship

Investment in human capital

Empowering women in developing countries

Inward investment to boost infrastructure and productivity

Help in adapting to climate change

Low Income Countries and the Global Recession

Anti-Poverty Strategies in Developing Countries

Lower income nations did not cause the global crisis but they have been affected in many ways by the fall-out from the credit crunch and the subsequent recession.


Unemployment and poverty in developed countries

The main causes of unemployment

Unemployment is a huge policy issue for governments around the world. In this section we focuson the problems facing developed nations. But taking a world view, the International Labour Officeestimates that the global unemployment rate for 2009 was estimated at 6.6 per cent. That meansthat 212 million people were unemployed.

Cyclical unemployment

Structural unemployment

Frictional unemployment & other causes

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Policies Recent examples in the UK

Macroeconomic stimulus policies

Employment subsidies

Attracting inward investment

Investment in human capital

Taxation and welfare reforms

Support to encourage entrepreneurship


Session 3 Macroeconomic policies during the global economic crisis

Main Macroeconomic Policy Options

The world recession has prompted a remarkable attempt by many countries to use macroeconomicpolicies to stabilize confidence, demand, output and jobs. Many nations have been hit badly by external and domestic shocks and some have been taken into “intensive care”! The NICE decade –a long period of non-inflationary continuous expansion – has come to an end and some economistsnow believe that developed nations will suffer from a DRAG decade – deficit reduction anemicgrowth!

At A2 level you will need to use some of the AD/AS analysis that was covered last year in the ASeconomics course. But for higher marks you should show a good up to date understanding of whathas been happening. And be willing and able to evaluate the possible consequences of the variouspolicies chosen. We will look at stimulus policies in different countries and also consider some of thedifficulties facing countries inside the Euro Area.

Monetary Policy• Changes in policy interest rates• Quantitative easing (QE)• Attempts to change the external value of the currency• Changes in the availability of credit (lending rules)

Fiscal Policy• Automatic stabilisers• Discretionary increases in government borrowing

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Monetary Policy in the recession

Monetary Policy• Policy interest rates• The exchange rate (depending on the choice of exchange rate system)• The availability of credit in the financial system

To influence• The level and growth of aggregate demand and output• Meet an inflation target and achieve price stability


Why have central banks cut interest rates to ultra low levels

1 Response to the credit crunch

2 Risks of price deflation

3 To prevent an economic depression

4 To stabilize confidence and demand

Stabilizing the economy – interest rates and the importance of the output gap

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The Liquidity Trap

Cheap credit but limited loan availability

Damaging effect of low interest rates on savers

Lengthening time lags for interest rates to have an impact

Does monetary policy work anymore?

How effective is monetary policy in achieving its aims? The ultra-low interest rates of the last couple of years ought to have had a big effect on economic activity. But there are good reasonsfor thinking that the impact of monetary policy has diminished. Some economists now talk about a liquidity trap effect.

Paul Krugman on the problems of being in a liquidity trap“Being in a liquidity trap reverses many of the usual rules of economic policy. Virtue becomes vice:attempts to save more actually make us poorer, in both the short and the long run. Prudence becomes folly: a stern determination to balance budgets and avoid any risk of inflation is the roadto disaster. Mercantilism works: countries that subsidize exports and restrict imports actually dogain at their trading partners’ expense.”

Interpreting this statement


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Quantitative Easing (QE)

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.

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

Revision notes on quantitative easing


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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Justifying higher government borrowing Economic risks of a high budget deficit

Economics of the budget deficit

Fiscal policy has been used to actively manage demand in the UK and in other countries duringthe recession. A rising budget deficit is an expansionary fiscal policy. But what are the likely consequences of huge state borrowing?

Fiscal deficits – the economic benefits and risks


Evaluation: The Importance of the Fiscal Multiplier

The fiscal multiplier measures the final change in national income that results from a deliberatechange in either government spending and/or taxation. Several factors affect the likely size ofthe fiscal multiplier effect.

Factor Comment

1 Choice of stimulus: Tax cuts or higher government spending?

2 Taxes: Who are the beneficiaries of tax reductions?

3 Expectations of taxation in the future

4 Availability of credit for businesses affected by fiscal stimulus policies

5 Openness of the economy – and the level of the exchange rate

6 Monetary policy response to a large rise in government borrowing

7 Amount of spare capacity in the economy (size of the output gap)

8 General level of consumer & business confidence / uncertainty

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Analysis: Recession and the impact of automatic stabilisers

When an economy suffers one or more domestic or external shocks, there are some natural automatic stabilisers at work that ought to help moderate or dampen the effects on demand,GDP profits and jobs without any explicit decisions from a government. The world recession of 2009 has brought these stabilisers into focus.

Automatic Stabilisers1 Welfare payments2 Floating exchange rate3 Public sector jobs4 Reduced tax take


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Build the case for a higher inflation target

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2

3

The risks of allowing inflation to be higher

1

2

3


Session 4 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 macro 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 good 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!

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Session 4 Study Notes

The end of the NICE decade

Dangers of a permanent loss of output and a slower underlying rate of growth


NationalOutput

Time

Trend

A deep recession may cause damage to an economy’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

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Session 5 Aiming for the A* - improving your evaluation and analysis skillsIn this session we will look at two questions – one requiring analysis and one requiring evaluation.We will then look at approaches to the question that provide hints on how to score high marks on analysis and critical evaluation in your A2 papers. After this we concentrate on evaluation skillsthat can be applied to every question. And we will flag up some handy evaluation phrases that cansignpost your attempts at evaluation in the exam.

Practice Questions

The chart above shows the annual rate of consumer price inflation for four countries over the period from 2005 through to 2010. In the exam you will be given some stimulus material in theform of charts, tables and written extracts. It is essential that you make effective use of this material in your answers. We will do this in our discussion of these two questions:

1 Analysis: Explain why inflation rates may differ between countries2 Evaluation: Evaluate the view that low inflation should no longer be the number

one priority for macroeconomic policy

Take ten minutes or so to jot down some thoughts to these questions in the space provided onthe next page. We will then take you through some suggestions for these questions.


Jot down your answers here

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New A2 Unit 4 Macroeconomic Exam Questions (AQA)

Note: 10 mark questions appear in the data response question, 15 mark questions appear in the main essay paper. 25 mark questions appear in both thedata and essay sections.

Analysis questions

Explain the concept of economic growth and analyse two ways in which international trade can increase a country’s economic growth (10 marks)Explain the term ‘recession’ and analyse two possible causes of a recession (10 marks)Explain the concept of the natural rate of unemployment and the factors which might determine it (15 marks)Explain how fiscal policy might be used to bring about supply-side improvements to an economy (15 marks)Explain the factors which help determine the exchange rate of a currency (15 marks)

Evaluation questions

Using the data and your economic knowledge, assess the possible impact on the UK economy of greater openness to world markets (25 marks)Using the data and your economic knowledge, assess the possible effects on UK macroeconomic performance of an external economic stimulus, whether arising from other EU members or from other parts of the world (25 marks)Evaluate the consequences for UK unemployment of a movement away fromspending and importing towards saving and exporting (25 marks)The level of UK public sector spending grew from 37% of GDP in 1997 to over 45% in 2008. To what extent do you regard such an expansion of the public sector as beneficial to the UK economy? (25 marks)In a floating exchange rate system, a currency may be subject to frequent fluctuations in its external value. Discuss the possible economic consequences of such fluctuations for the achievement of a country’s macroeconomic objectives. (25 marks)

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Revision resources from Tutor2uAhead of the exams this summer our economics blog will be carrying daily revision updates,news and comment on economic events and useful articles on exam technique. Have a look at our free blogs and other resources by going to

www.tutor2u.net/blog/index.php/economics


UK Economy at a Glance Recession Recovery

2009 2010 Comment

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

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

Investment -14.4 -0.5 Deep cut in capital spending last year - less severe in2010 but weak demand holds back investment

Stockbuilding (% GDP) -1.2 1.0 Many firms cut back on stocks/ production in 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 again in 2010

Exports -10.9 4.8 Exports hit by sharp fall in global output/trade in 2009.More positive in 2010 - weak sterling helping?

Imports -12.1 3.0 Imports slumped as UK went into downturn (UK hashigh income elasticity of demand for imports)

GDP -4.9 2.0 Deep recession (-6.2% over course of recession) -scraping towards 2% growth in 2010 (the new trend?)

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

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

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

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

Average earnings (inc. Bonuses) -0.1 3.4 Negative earnings growth for millions in 2009 - pay cutsand pay freezes (but CEO pay remained strong)

RPI Inflation -0.5 3.8 Some deflation in 2009 (mainly due to big cuts in mortgage interest rates) - RPI spikes higher in 2010

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

Real wages (deflated by CPI) -1.0 -2.6 Important data - in this recession, real wages have fallenfor a significant number (wage flexibility?)

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

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

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

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

Government debt (% of GDP) 68.6 80.3 Sharp rise in government debt (although lower thanmany 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 imports priced in Ss

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

Base (policy) interest rate (%) 0.5 0.5 Policy interest rates set to remain below 1% for at leastthe rest of the year - MPC in wait and see mode

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

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A2 MACRO Key Term GlossaryAAA credit rating The best credit rating that can be given to a corporation's bonds, effectively

indicating that the risk of default is negligible.Accelerator effect Where planned capital investment is linked positively to the past and expected

growth of consumer demand.Accommodatory policy A neutral macroeconomic policy stance in the face of an economic shock. For fiscal

policy, generally means keeping tax and government expenditure rates unchanged.For monetary policy, generally means keeping (real) interest rates unchanged.

Aggregate supply shock Either an inflation shock or a shock to potential national output; adverseaggregate supply shocks of both types reduce output and increase inflation.

Animal spirits The state of confidence or pessimism held by consumers and businesses.Automatic stabilisers Automatic fiscal changes arising automatically as the economy moves through

different stages of the business cycle - for example a fall tax that the governmenttakes out of the circular flow in a recession.

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

Beggar my Neighbour This is an economic policy that seeks to promote a country's economy at the expense of another country. An obvious example is the use of tariff barriers. Acountry may place tariff on imports to help promote local domestic industry. Thismay help local unemployment, but, be at the expense of the other country's exportsector.

Behavioural economics Branch of economic research that adds elements of psychology to traditional modelsin an attempt to better understand decision-making by investors, consumers andother economic participants.

Bond Both companies and governments can issue bonds when they need to borrowmoney. The issue of new government debt is done by the central bank and involvesselling debt to capital markets.

Brain drain The movement of highly skilled or professional people from their own country to another country where they can earn more money.

BRIC economies The BRIC grouping – Brazil, Russia, India and China – has become short hand forthe rise of emerging markets in the global economy. The BRICs already have a bigger share of world trade than the USA.

Bubble When the prices of securities or other assets rise so sharply and at such a sustainedrate that they exceed valuations justified by fundamentals, making a sudden collapse likely (at which point the bubble "bursts").

Budget deficit Occurs when government spending is greater than tax revenues. The UK budgetdeficit 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 abouthow much to spend on new capital goods.

Capacity The amount that can be produced by a plant, company, or economy (industrial capacity) over a certain period, if current resources (including capital, workers,etc.) are used to their fullest extent.

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

Capital flight The rapid movement of large sums of money out of a country. There could be several possible reasons - lack of confidence in a country's economy and/or its currency and political turmoil.

Capital flows Movements of capital between countries. Outward capital flows are movements ofdomestically-owned capital abroad; inward capital flows are movement of foreignowned capital to the domestic economy.

Capital stock The value of the total stock of capital inputs in the economy – affected by the rateof net investment spending.

Capital-labour substitution Replacing workers with machines in a bid to increase productivity and reduce unitcosts. This can lead to structural unemployment.

Carry trade A strategy in which an investor borrows money at a low interest rate in order to invest in an asset that is likely to provide a higher return.

Car scrappage scheme This is a scheme co-funded with the car industry that had the objective of increasingthe demand for cars in the UK.

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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 the standard of living as measured by per capita GDP.

Claimant Count The number of people claiming unemployment-related benefits. Since October1996 this has been defined as the number of people claiming Jobseeker's Allowance.

Classical LRAS The classical LRAS curve is drawn as vertical because classical economists arguethat a country’s productive capacity is determined by factors other than price anddemand such as investment and innovation.

Classical unemployment Classical unemployment is the result of real wages being above their market clearing level leading to an excess supply of labour.

Clean float A currency exchange rate that varies (or floats) according to market forces, freefrom government intervention.

Comparative advantage Comparative advantage refers to the relative advantage that one country or producer has over another. Countries can benefit from specializing in and exportingthe product(s) for which it has the lowest opportunity cost of supply.

Competitive devaluation When a country tries to devalue its currency to increase its international competitiveness. However, this often encourages other countries to also devalueleading to only temporary increases in the competitiveness of exports.

Consumer confidence Expectations about the future including interest rates, incomes and jobsCounter-cyclical Not following the normal pattern of business activity, for example increasing when

other activities are decreasing.Countervailing tariffs Tariffs (duties) that are imposed by a country to counteract subsidies provided to

a foreign producer.Credit crunch When creditors become reluctant to lend money to businesses or individuals

because of the increased risk of default due to adverse economic or political conditions.

Creeping inflation Small rises in the general level of prices over a long period of inflation. Creeping protectionism A period of time where import tariff rates rise and where countries introduce

quotas and barriers to the mobility of labour and capital.Currency union A group of countries (or regions) using a common currency – for example the 16

countries that have entered the single European currency.Current account deficit The amount by which money relating to trade, investment etc going out of a country

is more than the amount coming in.Cyclically adjusted Adjusting the value of an economic variable e.g. the budget deficit for the effects

of the business cycle.Debt burden The amount of debt that a business or country has normally expressed as a share

of GDP.Debt deflation High levels of debt leading to falling asset prices.Debt forgiveness The cancelling by a creditor of a debt to a country or a company.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.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.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 in governmentpolicy spending, direct and indirect taxation and borrowing.Discretionary income Disposable income adjusted for spending on essential bills such as fuel.Disequilibrium Disequilibrium unemployment comes about when the aggregate demand for unemployment labour is less than the aggregate supply of labour at the current real wage rate

and market forces are failing to correct the problem.Double dip recession When an economy goes into recession twice without having undergone a full

recovery in between.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 is below its costsof production.

Economic nationalism The idea that a country's economy will perform best if its industries are protectedfrom competition, for example by taxes on imported goods.

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.


Emerging markets The financial markets of developing countries.Expansionary monetary A policy by monetary authorities to expand money supply and boost economic policy activity, mainly by keeping interest rates low to encourage borrowing by

companies, individuals and banks.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.Fiscal drag The tendency of income from taxation to rise when an economy is growing. This

helps to slow consumer spending and corporate activity, and thus acts as a counterbalance to unrestrained growth.

Fiscal stimulus Government measures, normally involving increased public spending and lowertaxation, aimed at giving a positive jolt to economic activity.

Fixed exchange rate An exchange rate that is fixed against other major currencies through action bygovernments or central banks, usually within small margins of fluctuation aroundthe central rate. Likely to involve periodic intervention in the foreign exchange market by one or more central banks to buy or sell the currency in question if itmoves below or above its margins.

Foreign direct investment FDI is the acquisition of a controlling interest in productive operations abroad bycompanies resident in the home economy. May involve the creation of new productive capacity such as a new factory.

Foreign exchange The reserves of gold or foreign currencies (e.g. US dollars or Euros) typically heldreserves by central banks on behalf of their national government.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.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 thanan equal share of income.

Gilts Government bonds paying a fixed amount of money (‘coupon’) as interest annuallyand redeemable at face value on maturity.

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

Golden Rule A rule introduced by the Labour government which says that borrowing on stateprovided goods and services should be zero over the course of one economiccycle. Borrowing is used to finance capital investment.

Hard landing A full-scale recession shown by a decline in real national output.Hidden unemployment Unemployment which is known to exist but is not included in the official

government figures.Hot Money Money that flows freely and quickly around the world economy looking to earn

the best available rate of return. It might be invested in any asset whose value is expected to rise (e.g. property or shares) or simply be placed in an account offering the best real rate of interest.

Infant industry New industry that requires government protection from overseas competition (forinstance through the setting of import tariffs) in order to develop.

Inflation target The Government sets the Bank of England a CPI inflation target, which is currently2 per cent.

Infrastructure The transport links, communications networks, sewage systems, energy plants andother facilities essential for the efficient functioning of a country and its economy.

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

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

Investment income Interest, profits and dividends from assets owned and located overseas.

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J Curve Effect The effect of currency depreciation on the trade deficit depends on price elasticityof demand for exports and imports. In the short term, demand is often inelastic andthe J Curve effect says a trade deficit can actually worsen after depreciation, butget better in the medium term.

Job search The process by which workers find appropriate jobs given their tastes and skills.Keynesian economics The economics of John Maynard Keynes. The belief that the state can directly

stimulate demand in a stagnating economy. For instance, by borrowing money tospend on public works projects like roads, schools and 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.LIBOR London Interbank Offered Rate and - used by banks world-wide to determine the

rate at which they lend to each other - whether receiving or giving loans. Liborrates 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, globalperformance trade and living standards. Macro stabilization A coordinated set or group of mostly restrictive fiscal and monetary policies aimedpolicies at reducing inflation, cutting budget deficits, and improving the balance of payments.Managed floating An exchange rate that is basically floating but subject to intervention from timecurrency to time by the monetary authorities, in order to resist fluctuations that they

consider to be undesirable.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.Mercantilism The notion that the wealth of a nation was based on how much it could export in

excess of its imports, and thereby accumulate precious metals. Applied in themodern context to countries accumulating huge trade surpluses in goods or services and focusing on export-led growth.

Monetarism School of economic thought that considers money supply as the main factor influencing the economy, and monetary policy as the key instrument of governmentdecision-making. Controlling money supply should ensure steady economic growthand a healthy price environment. Opposed by the Keynesian school, which considers fiscal policy as the key macroeconomic tool.

Money illusion Money illusion occurs when people confuse nominal and real values when makingeconomic decisions. Money illusion is most likely to occur when inflation is unanticipated, so that people’s expectations of inflation turn out to be some distance from the correct level.

Money supply The entire quantity of a country's commercial bills, coins, loans, credit, and otherliquid instruments in the economy.

Moral hazard When an insured party decides to take higher risks because they perceive theirlosses will be covered – often linked to the excessive risk-taking by banks knowingthat central banks might rescue them.

Multiplier effect If there is an initial injection (e.g. a rise in exports) into the economy then the finalincrease in AD and Real GDP will be greater.

NAFTA North American Free Trade Agreement - a free trade area agreement signed by theUS, Canada and Mexico.

NAIRU Non-accelerating inflation rate of unemployment: the number of people withoutwork that some economists say is necessary at a particular time in order to prevent prices rising too fast.

National debt The total amount of debt that the government owes the private sector.


Negative equity Negative equity occurs when the value of an asset falls below the outstandingdebt left to pay on that asset. Term is most commonly used in connection withproperty prices and describes a situation where the market value of a house isless than the existing mortgage debt.

Negative interest rate An interest rate that is below zero. For real interest rates, this can occur when theinflation rate is higher than nominal interest rates.

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

in a given time period.Neutral interest rate A neutral interest rate is a rate of interest that neither deliberately seeks to

stimulate aggregate demand and growth, nor deliberately seeks to weaken growthfrom its current level. In other words, a neutral rate of interest would be that whichis set at a level which encourages a rate of growth of demand close to the estimated trend rate of growth of real GDP.

Non-inflationary growth Sustained growth of real national output whilst maintaining price stability Open market operations Central bank intervention in money markets where it buys and sells securities to

control the money supply and the level of interest rates.Output gap The difference between actual and potential national output. A negative output

gap after a recession implies that an economy has a large margin of spare productive capacity.

Overseas assets Assets such as businesses, shares, property which are owned in overseas countries and which might generate a flow of investment income which is a credititem on the current account of the balance of payments.

Paradox of thrift The basic concept is that if people save more in a recession, it will reduce consumption and thus aggregate demand will fall, impeding economic growthand, in fact, lowering the general level of savings.

Phillips 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.Potential output The economy's maximum productive capacity in a physical sense. The largest

output that could be produced, given the prevailing state of technology, with allavailable labour, capital and land fully utilised.

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

per person-hour.Protectionism The use of tariff and non-tariff restrictions on imports to protect domestic

producers from foreign competition.Purchasing power parity Method of currency valuation based on the premise that two identical goods in

different countries should eventually cost the same. This is illustrated by the BigMac index.

Rational expectations Where decisions are based on current information and anticipated future events.Reserve currency A foreign currency that is held in countries' official reserves because of its global

importance as a medium of exchange and its inherent stability.Ricardian equivalence The argument attributed to David Ricardo that government budget deficits have

no lasting effects on economic activity. Rational taxpayers are supposed to anticipate that tax cuts today will mean tax increases in future, and so save morewhen the government saves less.

Quantitative easing Central banks flood the economy with money by printing new notes, to increasethe supply of money. The idea is to add more money into 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 importedinto a country in a given period of time.

Real disposable income Income after taxes and benefits, adjusted for the effects of inflation.Real interest rate The nominal rate of interest adjusted for inflation.Real wage The nominal wage adjusted for the effects of inflation.Relative deflation The term “relative deflation” is generally used to describe an economy with an

inflation rate, which has not necessarily descended into negative territory, but ismarkedly lower than comparable economies.

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Remittances Sending of money to people in another country for example migrant workers sending some of their wages to their home country.

Retail Price Index (RPI) The RPI is broadly similar to the CPI but includes mortgage repayments and sometaxes, and excludes the top 4 per cent of earners. It is used to calculate increasesin 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.Soft landing A slowdown in activity but which does not result in a recession.Sovereign wealth A government or state run fund usually created by profits from natural resourcesfund (SWF) such as oil, gas or minerals. Highly secretive, their assets grew dramatically when

oil prices rose to record levels. Some of the largest SWFs are in the oil-rich Middle East.

Spare capacity When a business is not making full use of its available capacity – there are sparefactors of production including land, labour and capital. When an economy hasplenty of spare capacity, short run aggregate supply tends to be elastic.

Special drawing rights A unit of money created by the IMF. Each member country can borrow SDRs atfavourable interest rates from the IMF's reserves when they are needed for reasons related to a country's balance of payments.

Stability and growth pact EU's fiscal rule intended to maintain discipline in the public finances of Euro Areamember-states. The pact sets a limit for government budget deficits of 3 per centof gross domestic product in normal times.

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

Sterling exchange The external value of sterling calculated using a weighted index of a basket ofrate index 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.Tariff 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 more workers.Time lags The time it takes for one change e.g. a change in interest rates to affect other

variables e.g. consumer confidence and spending.Toxic debt Loans that may not be repaid.Trade-off Choices have to be made between different objectives of policy.Transmission mechanism How a change in interest rates affects sectors of the economy.Trend growth The long run average growth rate – mainly determined by changes in the stock of

available factor inputs and also improvements in productivity.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 When the prospect of the loss of unemployment benefits dissuades those without.

work from taking a new job – creates a disincentives problemUnorthodox monetary Any policy undertaken, usually by central banks, that operates outside the usualpolicy parameters for influencing either the price or the quantity of money in an economy.

– this includes quantitative easing.Unit wage costs Labour costs per unit of output.Unsecured credit Credit not secured by another asset – i.e. money borrowed on credit cards.Velocity of circulation The average number of times a unit of money changes hands in an economy

during a given period - normally measured by dividing the total amount spent(GDP) by the amount of money available (money supply).

Wage price spiral A situation where workers bid for higher wages because they have seen their realincome eroded by rising prices. This can lead to a further burst of cost-push inflation in an economy.

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

technical assistance to developing countries. It normally targets public works andother essential capital or social projects.

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

Notes

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A2 Economics Macroeconomics Revision Workbook _ April 2010