Flashcards · J205 · Topic 3

Economic objectives and the role of government flashcards

46 cards on Topic 3, subtopics 3.1 to 3.8. Pick a subtopic or study them all.

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3.1 Economic growth

Economic growth and GDP: Economic growth: a rise in an economy's production over time, shown by a rise in real GDP. GDP: the money value of all final output made inside a country's borders in a set period, usually a year.
GDP rises from 2,000 to 2,090 billion while population rises from 40 to 41.2 million. Find growth and the change in GDP per capita.: Growth = 90 ÷ 2,000 × 100 = 4.5%. GDP per capita: 50,000 → 50,728, a rise of only about 1.5%, because population grew 3%.
The determinants of economic growth named in J205: Investment (more capital per worker), changes in technology, the size of the workforce, education and training, the availability of natural resources, and government policies such as infrastructure and tax incentives.
Real GDP versus nominal GDP: which one measures growth?: Real GDP, because it removes the effect of price changes. Nominal GDP can rise just because prices rose, with no extra output.
Costs and benefits of economic growth: Economic: higher incomes, more jobs and tax revenue, but a risk of inflation and uneven gains. Social: better health, education and housing, but inequality and congestion. Environmental: money for clean technology, but pollution and resource depletion.
Sustainable growth: Growth that serves people today while leaving later generations able to meet their own needs.

3.2 Low unemployment

Unemployment, labour force and the unemployment rate: Unemployment: having no job but being available for and looking for work. Labour force = employed + unemployed. Rate = unemployed ÷ labour force × 100: 1.2 million out of 20.0 million is 6.0%.
Four types of unemployment, each with its cause: Cyclical: weak total demand in a downturn. Frictional: moving between jobs. Seasonal: time-of-year demand. Structural: skills or location mismatch, often after an industry declines (often long-lasting).
Claimant Count: one strength and one limit: It counts people claiming unemployment-related benefits. It is quick and available by area, but it misses people who do not claim and changes when benefit rules change.
Consequences of unemployment for individuals, regions and the government: Individuals: lower income, debt, lost skills, poorer health and confidence. Regions: less local spending, shop closures, people moving away. Government: more benefit spending and lower tax receipts, with an opportunity cost.
The unemployment rate rises from 3.6% to 4.4%. Describe the change correctly.: It rose by 0.8 percentage points (4.4 − 3.6). As a percentage of the old rate that is 0.8 ÷ 3.6 × 100 ≈ 22.2%. Say which measure you are using.

3.3 Fair distribution of income

Income versus wealth: Income is money received over a period (a flow). Wealth is the value of assets owned less liabilities owed, at a moment (a stock).
The main types of income and their sources: Wages and salaries (labour), interest (savings and lending), rent (land and property), profit and dividends (enterprise and shares), and benefits and pensions (government transfers).
A household owns a house worth 200,000 and savings of 12,000. It owes 120,000 on a mortgage and 6,000 on a loan. Find its net wealth.: Net wealth = total assets − total liabilities = 212,000 − 126,000 = 86,000.
Causes of differences in the distribution of income and wealth: Education, skills and training; occupation and sector pay; unemployment and part-time hours; owning property and shares; inheritance; age, region and discrimination; and taxes, benefits and the minimum wage.
Consequences of a very unequal distribution of income: Poverty (poorer housing, health and education), weaker spending because poorer households spend most of any extra income, more benefits paid and less tax collected, and social tension. Some gap rewards skill and effort.
The richest fifth of households receive 44% of income and the poorest fifth 6%. Compare them.: The groups are the same size, so the richest fifth receive 44 ÷ 6 ≈ 7.3 times as much income per household as the poorest fifth.

3.4 Price stability

Inflation, deflation and the CPI: Inflation: a continuing rise in the average level of prices. Deflation: a sustained fall in it. CPI: a weighted index of a typical household's spending. Falling inflation means prices rise more slowly, not that they fall.
Pay rises from £2,500 to £2,650 while the price index rises from 100 to 112. What happens to real pay?: Real pay = 2,650 ÷ 112 × 100 = £2,366, a real fall of about 5.4% against £2,500. Nominal pay rose 6%, but real pay fell.
Demand-pull, cost-push and imported inflation: Demand-pull: spending grows faster than output. Cost-push: higher wages, raw materials, energy or indirect taxes passed on in prices. Imported: a weaker currency makes imports dearer.
Nominal value and real value: Nominal: measured in current money, not adjusted for prices. Real: adjusted for inflation, so it shows purchasing power.
Weights 0.5, 0.3 and 0.2 have price indices 106, 110 and 100 (base year = 100). Find the CPI and the inflation since the base year.: CPI = 0.5 × 106 + 0.3 × 110 + 0.2 × 100 = 53 + 33 + 20 = 106. Prices have risen 6% since the base year.
Consequences of inflation for consumers, producers, savers and the government: Consumers: purchasing power falls if pay lags. Producers: higher costs and uncertainty, weaker competitiveness if inflation is higher than abroad. Savers lose when interest is below inflation. Government: tax revenue rises and the real value of its debt falls.

3.5 Fiscal policy

Fiscal policy versus monetary policy: Fiscal: the government changes its spending and taxes. Monetary: the central bank (the Bank of England in the UK) uses interest rates. Fiscal acts on disposable income and public services; monetary acts on the cost of borrowing and reward for saving.
Balanced budget, budget surplus and budget deficit: Balanced: revenue equals spending. Surplus: revenue is greater than spending in a year. Deficit: spending is greater than revenue. Example: revenue 410, spending 385 gives a surplus of 25.
Expansionary fiscal policy: the chain and its risk: Lower taxes or higher spending → more disposable income and demand → more consumption → more output and jobs. Risk: higher prices if the economy is near full capacity, and more borrowing.
Progressive, proportional and regressive taxes: Progressive: the average tax rate rises as income rises (bands of 0%, 20%, 40%). Proportional: the same rate at every income. Regressive: the average rate falls as income rises (e.g. a sales tax on a necessity).
Evaluating fiscal policy: arguments for and against: For: direct and targeted, funds public services, can tackle a recession, can reduce inequality. Against: time lags, borrowing and interest payments, the opportunity cost of other uses, possible disincentives and tax avoidance.
A 2 per-unit tax raises the price buyers pay from 10 to 11.50. Who bears the tax?: Buyers bear 1.50 of the 2 and sellers bear 0.50 (they now keep 9.50). The more inelastic the demand, the more of the tax falls on buyers. Revenue = tax × new quantity.

3.6 Monetary policy

Monetary policy: Use of interest rates (and sometimes the money supply) by the central bank to influence the economy.
What happens when the central bank cuts interest rates?: Borrowing is cheaper and saving earns less → more consumption and investment → higher total demand → growth and more jobs → but more pressure on prices.
A rise in interest rates: effect on borrowers, savers, firms and consumers: Borrowers worse off, savers better off, firms invest less and consumers spend less, so demand, growth and inflation all slow.
A machine costs 12,000 and adds 840 a year of profit before interest. Is it worth borrowing for at 5%? At 9%?: Return = 840 ÷ 12,000 = 7%. At 5% interest is 600, a gain of 240. At 9% interest is 1,080, a loss of 240. Higher rates reduce investment.
Limits of monetary policy: Time lags, weak confidence (people may not borrow even when rates are low), banks may not pass on the change, heavily indebted households, and low rates hurt savers.
Real interest rate (approximate): Nominal interest rate − inflation. A 3% rate with 4% inflation gives about −1%: savings lose purchasing power.

3.7 Supply side policies

Supply side policy, with examples: Government action to raise the economy's productive capacity: education and training, infrastructure, support for research, lower taxes on work or profits, less red tape and more competition. It suits long-run goals but works too slowly alone for a short-run problem.
How supply side policy links to the economic objectives: Growth: higher capacity raises potential output. Unemployment: training and job matching cut structural unemployment. Prices: lower costs and higher productivity ease price pressure. Distribution: skills can raise low pay, but tax cuts for the rich may widen gaps.
Evaluation chain for any supply side policy: Benefit: potential output rises, so growth is possible without inflation. Cost: government spending or lost tax revenue, with an opportunity cost. Limit: time lags and uncertain results. Judgement: sensible for the long run.
Output of £30bn is made by 1.5 million workers. Training raises output by 1.5%. Find output per worker before and after.: Before: 30bn ÷ 1.5 million = £20,000. After: 30.45bn ÷ 1.5 million = £20,300.
Supply side policy versus demand-side policy: Supply side policy raises long-run productive capacity. Demand-side policy (fiscal and monetary) changes short-run spending.

3.8 Limitations of markets

Negative and positive externalities: market output and the usual policy fix: Negative (pollution, congestion): market output too high; tax, regulation or information. Positive (education, vaccination): market output too low; subsidy, state provision or information. Markets ignore effects on third parties.
Externality: A cost or benefit to a third party, not reflected in the market price.
Social cost and social benefit: Social cost = private cost + external cost. Social benefit = private benefit + external benefit. Example: private cost £9 + external cost £2.50 = social cost £11.50 a unit.
The government policies J205 names for correcting externalities: Taxation and subsidies, state provision, legislation and regulation, and information provision.
A £3 tax raises the price from £12.00 to £13.80 and 5,000 units are sold. Find each side's burden and the revenue.: Consumers bear £1.80 (60%), producers £1.20 (40%). Revenue = 5,000 × £3 = £15,000.
State provision versus a subsidy: State provision: the government supplies the good itself, funded by taxation. Subsidy: the government pays part of the cost so private firms supply more at a lower price. Both have an opportunity cost.