25.

economic growth
Economic growth: increase in the level of output.

GDP: gross domestic product: market value of all final goods/services produced in a period (usually yearly), an internationally
recognised measure of national income
GDP PER CAPITA= GDP/POPULATION

Limitations of GDP as a measure of growth:

- inflation: If GDP increases by 5% & prices increase by 5% there is no economic growth
- population changes
- statistical errors: Gathering the data needed to calculate national income is a huge task. The govt. collects 1000000s of
documents from firms, individuals & other organisations. Unfortunately, errors are made because the information has been
entered inaccurately or left out. Therefore, the true value of GDP is never really known.
- the value of home-produced goods: Some goods/services aren’t traded; therefore, economic activity is not recorded.
- the hidden economy: Sometimes paid work goes unrecorded, the transactions become part of the hidden, ‘black’ or informal
economy. People may do a variety of jobs for cash & do not record transactions.
- GDP & living standards: GDP is used to measure living standards. However, just because GDP rises, it doesn’t automatically mean
that living standards have also risen. Factors such as how much leisure time people have has to be considered
- external costs: GDP doesn’t take external costs such as environmental costs into consideration; it doesn’t measure well-being of
society.

The economic cycle:

Boom: peak of the economic cycle where GDP is growing the fastest.
- existing firms will be expanding & new firms will be entering the market. Demand will be rising, jobs will be created, wages will be
rising & the profits made by firms will be rising (prices also rise)

Downturn: period in the economic cycle where GDP grows but more slowly
- demand for goods/services will stop increasing & begin to fall, unemployment will start to rise & wage increases will slow down.
Many firms will stop expanding, profits may fall & some firms may leave the market (prices will rise more slowly)

Recession or depression: period of temporary economic decline which trade & industrial activity are reduced, generally identified
by a fall in GDP in two successive quarters.
- when GDP is flat & is at the bottom of the cycle this is referred to as depression or slump. Poverty increases, demand falls,
unemployment rises sharply, business confidence is very low, bankruptcies rise & prices become flat (a less severe version is called
a recession)

Recovery:
- when GDP starts to rise again, there is an upswing in the economy. Businesses & consumers regain their confidence & economic
activity is on the increase. Demand starts to rise, unemployment begins to fall & prices start to rise again

Impact of economic growth

- more output = more workers (less unemployment) + govt. spends more on trying to open up new jobs
- more output = standards of living increase as disposable income increases + less time working + people can retire earlier + can
afford healthier alternatives meaning more life expectancy
- more output = less poverty (as more jobs are available)
- more output = productive potential of the country can increase (PPC shifts outwards)
- more output can cause the economy to overheat this is when demand rises too fast, causing prices & imports to rise triggering
inflation.
- more output = bad effects on the environment. Economic growth means the future generations will have fewer non-renewable
resources this is called unsustainable growth.
 26. inflation
What is inflation?
Aggregate demand: total demand in the economy including consumption, investment, government expenditure & exports minus
imports
Inflation: rate at which prises rise, a general & continuing rise in prices
deflation: period where the level of aggregate demand is falling

consumer price index (CPI): measure of general price level (excluding housing costs)
retail price index (RPI): measure of the general price level, which includes house prices & council tax

types of inflation:
demand- pull inflation: inflation caused by too much demand in the economy relative to supply.

cost-push inflation: inflation caused by rising business costs

the relationship between inflation & interest rates:

interest rates: price paid to lenders for borrowed money; it’s the price of money
monetarists: economists who believe there is a strong link between growth in the money supply & inflation

the impact of inflation:

- PRICES: high inflation = high prices
purchasing power of money: amount of goods/services that can be bought with a fix sum of money
- inflation reduces the purchasing power of people this means they can’t buy as much with their income. Therefore, households
will experience a fall in their living standards. However, if incomes are rising as fast than prices, this may not be a problem for
individuals.

- WAGES:
- When prices are rising, workers need to increase their wages to compensate for the loss in purchasing power, if workers
negotiate higher wages with their employers they get more money. However, as a result of higher wages firms may need to raise
prices as costs have risen. This creates a wages/prices spiral.

- EXPORTS: high inflation = high export prices

- if inflation is higher at home than in other countries, firms may find it difficult to sell in overseas markets, this is because the
prices of exports rise. As a result, demand for exports is likely to fall which means that the balance of payments is affected
negatively. Falling demand for exports will also result in job losses for people employed by businesses that sell goods abroad.

- UNEMPLOYMENT: high inflation = less unemployment

- high levels of inflation usually mean that aggregate demand is rising, this means output also increases which requires more
workers.

- MENU COSTS: costs to firms of having to make repeated price changes

High inflation = high menu costs

- SHOE LEATHER COSTS: costs to firms & consumers of searching for new suppliers when inflation is high
High inflation = high shoe leather costs

- UNCERTAINTY: high inflation = more uncertainty

- BUSINESS & CONSUMER CONFIDENCE:

hyperinflation: very high levels of inflation; rising prices get out of control
- inflation might make consumers anxious they also become more cautious & less willing to borrow money. They may start to save
more & this will reduce demand, which may not be good for job security in the economy. Businesses may lose their confidence;
they may reduce their spending’s on products & cut down growth plans, they take less risks as a result the economic growth rates
tend to fall.

- INVESTEMENT: high inflation = less investment

- inflation often results in a decline in business investment as there is an uncertainty about future prices, & the lack of business
confidence among decision makers, investment projects are likely to be postponed or cancelled this will have a negative impact on
economic growth & the future level of employment in the economy.
 27. unemployment
Unemployment: when those actively seeking work are unable to find a job
- unemployment is a waste of resources as if people aren’t working they aren’t making contribution to the economic output
of the country hence the GDP will be lower. It also causes hardships on the people that don’t work as living standards
become lower.

How is unemployment measured?

EU uses the labour force survey which is carried out every month
- ILO (international labour organisation) defines unemployed people as:
Without a job, want a job, in the last 4 weeks + Out of work, & are willing to start in the next 2 weeks

Types of unemployment:
1. Cyclical or demand deficient unemployment: unemployment caused by falling demand as a result of a downturn in the
economic cycle
Laying off: to stop employing someone because there is no work for them to do
2. Structural unemployment: unemployment caused by changes in the structure of the economy such as the decline in an
industry. The three main types are:
- sectorial unemployment: occurs when people are laid off because the industry they work in is in decline
- technological unemployment: occurs when jobs that were previously done by people are now done by machines
- regional unemployment
3. Frictional unemployment: when workers are unemployed for a short period of time as they move from one job to
another.
- short term unemployment, isn’t classified as a problem as people usually treat it as a holiday (frictional unemployment is
up to 8 weeks)
4. Seasonal unemployment: unemployment caused when seasonal workers, such as those in the holiday industry, are laid
off because the season has ended.
- there is little that can be done to reduce it as it’s usually linked to the climate
5. Voluntary unemployment: unemployment resulting from people choosing not to work
- they may choose not to work because they aren’t prepared to work for the wages offered or perhaps because they don’t
like the idea of work in general.

Impact of unemployment:
- output: unemployment = low output unless it is due to new technology being introduced
National income & living standards will be lower

- use of scare resources: unemployment = waste of resources

National income is lower as when there is full employment in an economy, output will be higher & income per head will be
higher

- poverty: unemployment = increased poverty

In some developing countries, many people have never worked in their lives. There have never been any employment
opportunities for them. As a result, they have to live in poverty. The may try to support themselves at a minimum level by
growing some food on a plot of land.

Even in developed countries, most people who find themselves without a job suffer hardship. Their incomes fall because
state benefits are generally lower than wages. In extreme cases, unemployed people lose their homes because they can’t
afford mortgage payments. Sometimes the costs can extend to family break- ups & a lower self- confidence for those who
are long term unemployed.

- govt. spending on benefits: unemployment = higher govt. spending on benefits

When people are unemployed they are entitled to receive some financial benefit from the state. If unemployment levels rise,
the govt. has to allocate more money to unemployment benefit. E.g. the money could be better spent on education or health
care

- tax revenue: unemployment = tax revenue falls

Govt. has less to spend & may cut public sector services, they may also borrow more which will increase national debt or it
may have to increase tax rates.
- consumer confidence: unemployment = consumer confidence falls
Most people find themselves without a job have to suffer hardship, their incomes fall because state benefits are generally
lower than wages. As a result, these people lose confidence & play a less significant role in the economy. Also, people who
remain employed may start to worry about their own job security, their confidence is also negatively affected. They become
more cautious, which will result in lower levels of spending & probably more unemployment.

- business confidence: unemployment = low business confidence

When firms lay off workers, they have to pay them redundancy money, also the remaining workers may be demotivated
because they may fear they’ll be next. A firm will be left with spare capacity when laying people off & there is more likely to
be a fall in demand. Sales are likely to fall, as people have less to spend. As a result, they are likely to take less risk & may
postpone or cancel investment projects.

- society:
Sometimes unemployment can have an impact on local communities. E.g. in some towns/villages a large proportion of the
village may be employed by the same business. If the business closes down, local unemployment can be very high indeed. As
a result, the spirit in many of these communities worsens, such areas become run down. Smaller businesses start to struggle
& fail because their customers are suffering hardships. Households don’t have enough money to maintain their houses &
gardens & the residential environment starts to look uncared for

There may also be an impact on the wider society, e.g. losing a job can be psychologically hard on workers. Individuals may
doubt their value as a person this can lead to stress within relationships. Unemployed people are less likely to get married &
more likely to get divorced. It also leads to crime.
 28. balance of payments on the current account
balance of payments: record of all transactions relating to international trade
capital & financial account: that part of the balance of payments where flows of savings, investment & currencies are recorded
current account: part of the balance of payments where all the exports & imports are recorded
exports: goods/services sold overseas
imports: goods/services bought from overseas.
current account deficit: when value of imports exceeds the value of exports (current account balance is negative)
current balance: difference between total exports & total imports (visible & invisible)
current account surplus: when the value of exports exceeds the value of imports (current account balance is positive)
balance of trade or visible balance: difference between visible exports & visible imports
invisible trade: trade in services
visible trade: trade in physical goods
primary income: money received from the loan of production factors abroad
secondary income: government transfers to & from overseas agencies e.g. EU

the relationship between the current account & exchange rates:

exchange rate: price of one currency in terms of another
the position of international trade is influenced by changes in the exchange rate. If a country’s exchange rate gets stronger (which
means that 1 unit can buy more units of another currency), exports become more expensive & imports become cheaper. This
might result in fewer exports being sold & more exports being bought. The size of the current account deficit will increase.

The balance on the current account may also have an impact on exchange rates. E.g. if a country has a surplus on the current
account resulting from rising sales abroad, demand for that country’s currency will rise (foreigners will need to buy that country’s
currency to pay for the goods). This will increase in the demand for the currency could drive up the exchange rates, therefore, it
would get stronger.

reasons for deficits & surpluses

- quality of domestic goods: If a country develops a reputation for high-quality goods, it’s likely to enjoy rising sales from overseas
buyers, this will drive up the demand for exports & help improve a current account balance. It also increases demand from the
home market as consumers will prefer them to imports. This will also help improve the current account.
- quality of foreign goods: If goods/services from overseas are superior to those produced domestically, there will be an increase
in demand for these imports, this will have a negative impact on the current balance. The size of a current account deficit would
get bigger. There will also be less demand for home produced goods, which would result in lower domestic output & employment.
- price of domestic goods: Demand for goods/services is heavily influenced by the price. If domestic goods are expensive, owing to
rapid inflation, for example, then demand from overseas buyers is likely to fall. This will see a progressive worsening of the current
balance.
- price of foreign goods: If foreign goods are cheaper than those produced at home, there will be a rapid increase in demand for
imports. This will have a negative effect on the current account, reducing the size of a surplus.

The impact of a current account deficit:

- leakages from the economy: a persistent current account deficit suggests that a country is becoming increasingly dependent on
imports; consumers are buying goods produced outside the domestic economy, as a result, money flows out of the economy to
overseas businesses. This represents a leakage in the economy meaning output & employment levels in the domestic economy are
under threat

- inflation: current account deficit might mean a country is exposed to inflationary pressures. If the prices of imports go up, this will
be reflected in the general price level since many imported goods will be counted when the CPI is calculated. Rising import levels =
high domestic inflation levels. The greater the reliance on imports, the greater the threat of inflation when import prices rise

- low demand for exports: A country with a high current account deficit might be struggling to sell goods/services abroad. If
demand for exports is low, it might mean that the quality of goods/services is poor or the price is too high. A current account
deficit might reflect structural weaknesses in the economy. This means that domestic firms may struggle because they aren’t
competitive enough in certain industries.

- funding the deficit: If a country has a continuing current account deficit, it will need foreign currency to pay for the rising quantity
of imports that are being purchased. If the foreign currency to pay for the rising quantity of imports that are being purchased. If
the foreign currency reserves a country run low, it may be necessary to borrow. However, persistent borrowing may cause long-
term problems.
 29. Protecting the environment:
Business activities that damage the environment:
1. mining:
- open cast mining, where materials are extracted from a giant hole in the ground, is one of the most damaging activities of
all
- problem: many minerals are only available in small amounts, this means a large amount of earth have to be mined only to
find small quantities of valuable material.
- involves crushing rocks, which releases harmful materials, e.g. radioactive elements, asbestos like materials & metallic dust.
- during the process, waste material that is left over leaks into the ground, contaminating water systems & wildlife if not
managed properly.
- water that is contaminated can be accessed by humans for drinking, this will lead to catastrophic health issues.

2. power generation:
- electricity when produced by burning fossil fuels (coal & oil) is very damaging to the environment.
- the impacts include: emissions, release of hot water, climatic & visual impacts from cooling towers, solid waste disposal, as
disposal & noise,
- power plants need massive amounts of steam, when the water is returned to wildlife it is boiling warm & dirty; destroying
wildlife.
- power generation releases greenhouse gases which are released into the environment as acid rain (often found miles away
from the actual factory)
-nuclear power stations can leak radioactive material which can kill people & nature. If a leak occurs that area becomes
unusable. There is a problem of waste disposal, as radioactive waste has to be stored for 1000’s of years before it is safe to
release.

3. chemical processing:
- chemicals play an important role in everyday life e.g. used to cure diseases, increase crop yields, provide insultation
& more.
- chemicals also create negative impacts on human health & the environment
- refineries & chemical processing plants release hazardous air pollutants (HAPs), these can cause cancer.
- some chemical processes release volatile organic compounds (VOCs) which react with oxygen & nitrogen oxides, these
increase rates in asthma & lung/ heart diseases.

4. agriculture:
- the use of pesticides & fertilisers in farming causes negative environmental impacts as they usually end up in the sea, lakes
or oceans where they destroy aquatic wildlife.
- long term effects of pesticides on humans is still unknown, however farmers who face regular exposure suffer symptoms
such as headaches & hand tremors.
- farming & deforestation also contribute to global warming

5. construction
- construction industry produces the most waste than any other.
- activities such as land clearing, operations of diesel engines, demolition, burning & working with high toxic materials
contribute to air pollution.
- diesel & oil, paint, solvents, cleaners & other harmful materials contribute to water pollution.
- when land is cleared it causes soil erosion, resulting in silt & soil running into natural waterways, restricting sunlight &
destroying aquatic water life.

Ways businesses damage the environment:

1. visual pollution
- this is when a business causes something physically unattractive, e.g. smoke flowing from power plants, giant office blocks,
advertising hoardings, electricity pylons, smog, disused factories, construction sites & litter.

2. Noise pollution
- when a business causes excessive noise that causes disturbance in everyday life, e.g. jet engines, music & loud
conversations in pubs, bars & discos, machinery, vehicles & power tools, commercial traffic & heavy industrial machinery.
3. Air pollution
- this is when a business causes emission to be discharged into the atmosphere. From perhaps burning fossil fuels, emissions
from factories & other business activities & agricultural activities.

4. Water pollution
- when a business contaminates water by disposing toxic materials into water. From perhaps industrial waste, marine &
ocean dumping & sewage
- water pollution can cause marine life to be threatened, it also causes diseases in humans e.g. arsenic causes cancer.

Government intervention to protect the environment:

1. Taxation:
- the aim of imposing taxes is that those who damage the environment have to pay the subsequent costs. This reduces the
emissions & promotes production of clean energy, this creates new jobs & increases tax revenues.

2. Subsidies:
- the government offers grants, tax allowances & other subsidies to firms as an incentive to reduce activities that damage the
environment, e.g. giving a firm a subsidy to build a plastic recycling centre; this encourages households to recycle. They can
also offer subsidies for positive externalities, e.g. train stations are subsidised to reduce congestion on roads & reduce
carbon emissions.

3. Regulation:
- a range of legislation, regulations, guidelines & codes of practice exist in many countries which is designed to help protect
the environment.
- many governments employ specialist agencies to help monitor pollution levels. Such agencies are responsible for acting
against those who break environmental laws.

4. Fines:
- fines are common in many countries.
- firms are responsive to financial penalties as when imposed they reduce profits. Hence, fines act as an incentive to comply
with environmental laws

5. Pollution permits
- governments issue pollution permits; these documents give businesses the right to discharge a certain amount of polluting
material.
- this means a business can sell its pollution permit to another business if it has found a way of reducing its own level of
pollution.
- this is an incentive in the market that exists to introduce new technology that reduces pollution because pollution permits
can be sold for cash which helps raise profits.

6. Park provision
- governments establish national parks where business development & other commercial ventures are completely illegal.
- the parks are often very large areas of land, aim to preserve & protect areas of outstanding natural beauty this contains
wildlife, historic sites & scenery. They welcome visitors but restrict activities.
 30. redistribution of income
Income inequality: differences in income that exist between the different groups of earners in society, that is, the gap
between the rich & the poor. This can arise due to a number of reasons:
- workers with natural talent, a good education, valuable work experience will earn more
- people who don’t work such as pensioners receive less than those in employment
- people who own property, shares & businesses enjoy interest, dividends & rents.

Lorenz curve: graphical representation of the degree of income or wealth inequality in a country.

Absolute poverty: where people don’t have enough resources to meet all of their basic human needs.

Relative poverty: poverty that is defined relative to existing living standards for the average individual
- relatively poor people are to found at the bottom of a nation’s income scales. Their incomes will fall short of the levels
needed to provide an average living standard in their country where they live.

Relative poverty will also change over time as income levels change they usually rise; therefore, an individual receives an
increase in income that is higher than the average increase, that individual might move out’ve poverty or further away from
it.

Reasons to reduce poverty & inequality:

- meet basic needs:
If absolute poverty can be completely eliminated, the basic needs of people will be met. This would avoid the loss of life from
starvation & help children to grow up healthily.

- raise living standards:

If poverty can be reduced, living standards across the world would rise. If absolute poverty is eliminated, the basic needs of
people would be met. Although relative poverty would always exist it’s still possible to bring people out’ve it. Even with
relative poverty, ill health & early death are still problems.

If reducing poverty can raise living standards, more people would be educated. This would help to boost global economic
growth. As a result, there would be more employment, more income & more tax revenue for the govt. this could be spent
improving public services.

- ethical reasons:
Many people think poverty & income inequality should be reduced for ethical reasons. This means they believe it is the
moral duty of both people & govts. to help reduce poverty (however there are less people that think like this). Millions of
ethically minded people contribute in charities.

Govt. intervention to reduce poverty & income inequality:

Progressive taxation: where the proportion of income paid in taxes rises as the income of the taxpayer rises.
Regressive taxation: tax system that places the burden of the tax more heavily on the poor

If a govt. uses a progressive tax system, the gap between the rich & the poor might be closed, this is because people on
higher incomes will be paying more tax. However, if average incomes are rising rapidly, the people at the top of the income
scales will benefit more so the gap may widen. The gap is also more likely to close if the govt. gives poorer sectors of society
some of the tax it collects from those on higher incomes.

Redistribution through benefit payments:

In most developed countries, govts. have a welfare system, which is used to redistribute income in favour of the poor. Most
systems involve using tax revenues to make direct payments to those on low incomes & to those who can’t work at all. These
payments help boost incomes of some of the most at-risk people this reduced both relative poverty & absolute poverty.

Investment in education & healthcare:

If people are more educated they can be employed more. However, investment in education is very expensive. Investment in
healthcare helps reduce poverty, they also reduce mortality rates & life expectancy. If people are healthier, they will be more
productive in the workplace & this will increase economic growth.
 31. fiscal policy
Policy instruments: tools govt. use to implement their policies, such as interest rates, rates of taxation, levels of govt. spending.
Budget: govts. spending & revenue plans for the next year
Fiscal policy: decisions about govt. spending, taxation & levels of borrowing that affect aggregate demand in the economy.

Government revenue:
1. Direct taxes: taxes levied on the income earned by firms & individuals.
- income tax: tax on the amount earned by an individual (self-employed & employed have to pay this tax)
- social insurance taxes: imposed on people’s incomes but they are used for pension benefits & healthcare
- corporation taxes: levied on limited companies
- capital gains tax: levied on any financial gains when selling assets as a profit, such as shares, businesses & properties
- inheritance tax: paid on money that is inherited from people who die.

2. Indirect taxes: taxes levied on spending such as VAT

- sales taxes: imposed on spending such as value- added tax (VAT): tax on some goods/services businesses pay VAT on most
goods/services they buy & if they are VAT registered, they can charge VAT on the goods/services they sell.
- duties: imposed on goods such as alcohol, cigarettes & petrol
- customs duties: levied on imports
- council tax: collected by local authorities to help pay for local services such as refuse collection. It is levied according to the value of
residential property & is paid by the occupants
- business rates: collected by local authorities & contribute to the provision of local community services; paid by businesses
- stamp duties: paid when buying certain assets such as houses & shares

3. environmental taxes:
- landfill tax: imposed on the disposal of waste in landfill sites, linked with the weight of the waste
- climate change taxes: imposed on high amounts of electricity supplies, coal & gases
- aggregates levy: tax on sand, gravel & rock that is dig from the ground, designed to reduce the damage caused by quarrying

Fiscal deficit: amount by which govt. spending exceeds govt. revenue

Fiscal surplus: amount by which govt. revenue exceeds govt. spending
impact of fiscal deficits & fiscal surpluses:
- fiscal deficits:
National debt: total amount of money owned by a country
Over a long period of time, most govts. would prefer to avoid running a fiscal deficit. In a year when the govt. plans to overspend, it will
have to borrow money to fund the deficit. Consequently, if this builds up the national debt keeps increasing. This means the govt. needs
to spend more of its revenue repaying the debt. This also burdens the future generations as they have to pay off the excessive use of
debts. When analysing the size of the deficit it is usually compared to the GDP.

- fiscal surpluses: The impact of a fiscal surplus is likely to be positive. If a govt. collects more revenue than it spends in a year, the surplus
could be used in a number of ways.

The impact of fiscal policy on macroeconomic objectives:

Expansionary fiscal policy: fiscal measures designed to stimulate demand in the economy
Contractionary fiscal policy: fiscal measures designed to reduce demand in the economy

- inflation: Contractionary fiscal policy can be used to reduce inflation, the govt. can cut down its own spending levels or raise taxation,
this will reduce the disposable income & therefore reduce demand, relieving inflationary pressure.

- economic growth: expansionary fiscal policy can be used to help stimulate economic growth, increases in govt. expenditure will increase
aggregate demand. Cuts in taxes will also increase demand as firms & households will have more money to spend. Economic growth is
more likely to result from extra govt. expenditure on capital projects e.g. schools & transport

- unemployment: expansionary fiscal policy can help reduce unemployment. Tax cuts & govt expenditure help stimulate demand. To meet
this extra demand, firms will have to produce more this means more staff is needed. The govt. can help by directing its extra spending on
construction projects, as this industry is labour intensive, which means job creation will be higher.

- current account deficit: fiscal policy might be used to help influence the balance on the current account. E.g., if there is a large deficit on
the current account, contractionary fiscal policy will help reduce aggregate demand, this will reduce demand for imports

- fiscal policy & the environment: govts. use fiscal policies to tackle environmental problems e.g. by using landfill taxes & by using
subsidises to encourage eco-friendly activities.
 32. monetary policy
monetary policy: use of interest rates & the money supply to control aggregate demand in the economy
money supply: amount of money circulating in the economy
base rate: rate of interest set by govt. or regional central banks for lending to other banks, which in turn influences all other rates in the
economy
mortgage: legal arrangement where you borrow money from a financial institution in order to buy land or a house, & you pay back the
money over years. If you don’t pay regularly, the lender has the right to take back the property & sell it in order to get their money
rate of interest: price of borrowing money

the role of central banks in setting interest rates:

- implementing the govts. monetary policy & regulating the banking system
- acting as a lender of last resort to commercial banks
- controlling inflation & stabilising a nation’s currency
- setting interest rates

impact of interest rate changes on macroeconomic objectives:

- inflation: a way to reduce inflation is to slow down the speed at which the money supply is growing this is likely to involve raising the
rate of interest. When interest rates are higher, borrowing is likely to fall & the money supply grows less quickly this will help reduce
aggregate demand in the economy & limit price increases.

- unemployment: a govt. might use lower interest rates to reduce unemployment. If interest rates are cut, there would be an increase in
demand for loans. As a result, spending by firms & households would increase. This would increase aggregate demand & firms would
respond by producing more goods/services, this means they’d need more staff & unemployment would fall.

- the current balance: a govt. would use monetary policy to adjust the balance on the current account. For example, to reduce a deficit, a
govt. may decide to tighten the monetary policy. This would lower aggregate demand & reduce spending on imports. However, if interest
rates are raised, exchange rates might also increase. This would make exports more expensive, imports cheaper & worsen the current
balance. The overall effect on the current balance of higher interest rates depends on the following:

- the income elasticity of imports: if demand for imports were income elastic, higher interest rates would reduce demand for them. This
would improve the current balance.

- the strength of the link between interest rates & exchange rates: if the link is strong, higher interest rates will raise exchange rates.
Exports will become expensive & imports will become cheaper. The current balance would worsen.

- the price elasticity of demand for imports & exports: if they are both price elastic & the exchange rate does rise when interest rates rise,
imports will be cheaper & exports will be dearer. The current balance would worsen.

The mechanism by which interest rate changes affect consumers & firms:
- consumers: When interest rates fall, demand for loans from households will rise. Consumers are likely to borrow money to buy goods as
it is cheaper. Also, when interest rates fall, consumers with mortgages will notice that payments for it also fall. This means they have
more money to spend; increasing aggregate demand. This will also reward savers. However, if interest rates rise. Consumers try to
reduce borrowing as it becomes expensive. Mortgage payments will rise automatically. Therefore, households will have less disposable
income to spend.

- firms: Firms using borrowed money, such as mortgages, loans & overdrafts, to fund their business activity is likely to respond to changes
in the interest rate. For example, when interest rates fall, the interest payments on current borrowings will also fall this will help to boost
the profits as costs will be lower, this will also raise levels of business confidence & stimulate more investment. Since a large proportion
of business investment is funded through borrowing the returns are also likely to be higher. However high interest rates will raise costs,
lower profits, reduce business confidence & make entrepreneurs cautious as a result, investment in the economy is likely to fall.

There is also a link between interest rates & exchange rates. When interest rates fall, exchange rates are likely to fall too. If the exchange
rate falls the prices of exports become cheaper this means that demand for them will rise. Firms will benefit as they can sell more
goods/services. Also, the prices of imports will rise which means domestic consumers & firms will buy fewer. An increase in exports & a
fall in imports will increase aggregate demand, this will also help to improve the balance on the current account.

quantitative easing: buying of financial assets, such as govt. bonds from commercial banks, which results in a flow of money from the
central bank to commercial banks
real economy: part of the economy that’s concerned with actually producing goods/services as opposed to the part of the economy that
is concerned with buying & selling on the financial markets.
 33. supply side policies
-supply side policies: govt. measures designed to increase aggregate supply in the economy
- aggregate supply: total amount of goods/services produced in a country at a given price level in a given time period.

Impact of supply side policies on productivity & total output:

 Productivity: supply side policies generally improve the productivity of production factor this means that resources are
used more effectively & the productive potential of the economy can be increased
- improving flexibility: in the past, many believed that labour markets were too inflexible. E.g. trade unions were criticised for
forcing up wages & resisting the introduction of new working practices & new technology. This prevented labour productivity
from improving. To deal with the problem the govt introduced a range of anti-trade union legislation to weaken unions &
help labour markets work more freely e.g. closed shops & secondary picketing was illegal. As a result, there was less
disruption when new working practises & new technology were introduced. There were also fewer strikes relating to wages.
- training & education: of people receive more education & training the quality of the workforce will improve. This will help
improve labour productivity & increase aggregate supply. Some supply side policies are designed to stimulate more
competition. If a govt can make markets more competitive. This will help them raise productivity. Finally, productivity can be
increased with more investment. If businesses purchase new technology & update their production facilities, efficiency will
improve.
 Total output: supply side policies aim to increase the productive potential of the economy, with increased volumes of
output, national income will rise & living standards will be improved. Also, if the govt can increase supply, there is less
chance of demand-pull inflation & more jobs would be created. Therefore, unemployment will be lower.

Impact of supply side policies on macroeconomic objectives:

Definition: advantages: Disadvantages:
Privat The transfer of assets from a public sector - efficiency increases as the - state monopolies often become
isation: business to the private sector private sector aims towards private monopolies. As a result,
profit. consumers may be exploited. This
- competition increases which has led to price increases & poor-
increase innovation; quality services (particularly in
increasing aggregate supply water & energy distribution)
- lack of political interference. - increased unemployment as
firms always try to reduce costs
hence they may lay employees
off
- private businesses disregard the
environment
- loss of economies of scale
De when the govt. reduces/ eliminates - lowers barriers to entry into - inadequate or insufficient
regulation: restrictions on industries, often with the industries, which assists with regulation may bring problems.
goal of making it easier to do business. It improving innovation, - It can be difficult to create
removes a regulation that interferes with entrepreneurship, effective competition in an
firms' ability to compete, especially competition, & efficiency; this industry which is a natural
overseas. leads to lower prices for monopoly – high barriers to
tackles problems such as: customers & improved entry. It may create a private firm
- excessive paperwork quality. with monopoly power.
- obtaining unnecessary licenses - Producers have less control - Industries with initial
- having lots of people/committees to over competitors & this can infrastructure costs need govt.
approve a decision encourage market entry. support to get started. E.g. the
- various ‘trivial’ rules that slow down - taxpayers no longer have to electricity & cable industries.
business development pay for the expenses of - Customers are more exposed to
operating regulatory agencies, fraud & excessive risk-taking by
this means that consumers companies.
 have more discretionary - Social concerns are lost
income, & therefore more (damage to the environment)
money to spend on other - compromise of public services
items. with a poorer quality of provision.
- Businesses formulate their
own strategies/ processes
without govt. interference.
Education - govts can help by investing more in quality of human capital is - expensive & the returns in the
& training: schools, unis & colleges. They can also improved = workers are more investment isn’t seen for many
provide firms with incentives to invest in productive as people are more years.
training. They could offset training costs employable if they have more
against tax. skills.
Policies to - people who are jobless & are actively - fiscal policy can decrease - expensive for the govt. it can
boost regions seeking for work unemployment by helping to get into a huge debt
with high un - boosting human capital: education & increase aggregate supply &
employment: training – a long run strategy to make the the rate of economic growth.
workforce more employable & to raise the If firms produce more, there
level of productivity will be an increase in supply
- lower employment taxes to increase for workers & therefore,
labour demand: e.g. reduction in national lower supply deficient
insurance contributions unemployment
- stimulus to demand from both the public
& private sector: keeping aggregate
demand high to drive the creation of new
jobs
- improved export competitiveness to
provide an injection of demand into the
circular flow of income
- improving work incentives- making work
pay to reduce benefit dependency &
expand the size of the labour supply
Infrastructur A policy uses govt. uses fiscal policy to - improves transport & - to repair all the areas of
e spending: increase spending on certain communication systems this infrastructure to good condition
developmental assets in the govt e.g. will help private sector firms would cost trillions
hospitals, schools. This increases capital because people will be more - infrastructure investments are
input & total factor productivity, therefore geographically mobile & the unlikely to have any sustained
increasing aggregate supply distribution of goods will be impact on the unemployment
easier. rate as compared to the
- investment in schools & opposite.
hospitals will improve the
quality of human capital;
helping the private sector
firms because workers will be
better educated & healthier
Lower The pace of economic growth can be
Business accelerated if businesses can be
taxes to encouraged to invest more. Businesses
stimulate want to invest when they’re confident
investment: about the future & there are funds
available. The govt. can also play a role by
maintaining a stable economy & helping to
increase the flow of investment funds to
firms.
Lower Some people argue that high taxes on - the govt. Has less tax revenue
income taxes income & profit will reduce output in the meaning they can’t spend it on
to encourage economy this is as high taxes reduce the other things e.g. healthcare,
working incentive to work & discourage people schools, infrastructure etc
from setting up/developing businesses.
 34. relationships between objectives & policies
- austerity: official action taken by a govt. in order to reduce the amount of money it spends or the amount people spend.

UNEMPLOYMENT & INFLATION:

Policies to reduce inflation: if inflation gets out’ve controls this can be very harmful for an economy. Consequently, most
govts. are likely to act to reduce inflationary pressures as soon as it becomes a problem. Govts. often favour the use of
monetary policy to reduce inflation, this is because a govt. can quickly raise interest rates to reduce demand. In many
countries, central banks will automatically raise interest rates if they have been given an inflationary target to meet. When
interest rates are high, there will be a decrease in aggregate demand. This will help to reduce inflation but there may be
some serious negative effects, such as the following:
 Higher interest rates = discourage consumers/businesses from borrowing. Resulting in a fall of
consumption/investment reducing aggregate demand & lower economic growth. Unemployment is likely to rise.
 Higher interest rates = higher mortgage payments reducing their spending power & a fall in aggregate demand. Firms
will react by reducing capacity & laying of staff
 Firms will incur higher interest charges this will raise their costs & reduce their profits. they may invest less resulting
in lower aggregate demand
 Higher interest rates = discourage firms from borrowing to invest in new technology & expansion. This will hamper
their long-term development. They may also lose their competitive edge in foreign markets.
 If higher interest rates result in higher exchange rates it may be harder for firms to sell abroad. Exporters are likely to
react by laying off staff

Even if a govt. uses fiscal policy to reduce inflation, there will still be some negative effects
 Higher taxes & lower govt. spending could result in unemployment. E.g. if consumption falls as a result of higher
taxes, businesses will see a fall in demand they may react by cutting production & laying off workers. Lower govt.
spending means that services such as teaching & healthcare will be cut off
 People may suffer as a result of poorer govt services after the cuts in expenditure.

Possible trade-off
In the past, when govts have tried to reduce inflation, unemployment rises. This suggests that a trade-off exists between
inflation & unemployment. Many economists recognise this & suggest that a govt. will have to accept higher levels of
unemployment if it wishes to reduce inflation. Some economists say that if a govt. tries to reduce inflation very quickly;
unemployment will rise very quickly. However, the use of supply side measures to reduce inflation may avoid rising
unemployment as they’re designed to increase the supply of output rather than decrease aggregate demand. Unfortunately,
they are often slow to have an impact on the economy. Consequently, govts are more likely to use them together with other
measures to reduce inflation, rather than a sole measure

ECONOMIC GROWTH & INFLATION:

Policies to promote growth: govts around the world will be keen to see the economy grow when they are elected as
economic growth usually means living standards will improve & therefore the voters will be satisfied. To promote economic
growth, the govt. can use expansionary fiscal policy. This would involve lowering taxes or increasing government
expenditure. If taxes on households are lowered, people will have more disposable income. If they spend this extra money,
aggregate demand will rise & businesses will be encouraged to produce more. If businesses raise output levels, the economy
will grow. Similarly, if the govt. spends more, by employing more teacher etc. extra demand in the economy will be created.
Again, firms should respond to this by producing more & national income will grow. The govt could also use expansionary
monetary policy. If interest rates are lower, people will usually borrow more & spend more. Also, firms might decide to
invest more. If the cost of investment funds is lower, this will encourage businesses to develop new products, expand their
existing activities & set up new ventures. Extra investment will help to drive economic growth. A govt might also use
quantitated easing to stimulate growth this will help to increase the money supply & therefore aggregate demand

Possible trade-off
One of the dangers of policies designed to increase economic growth is that they may be too expansionary. As a result,
economy might become ‘overheated’ this means that firms will not be able to meet the rising aggregate demand & respond
by raising their prices instead of producing more. This will cause demand-pull inflation in the economy. Therefore, govts
need to be cautious. If they stimulate the economy too much, they will cause inflation. Suggest there is another trade off
between rapid economic growth & inflation. Inflation is more likely to be caused if there is limited capacity in the economy
or if factors of production are immobile. If firms are close to capacity & are finding it difficult to acquire sources, such as
skilled labour, then inflation is more likely to occur. However, the use of supply-side policies to promote growth might help
to reduce inflationary pressures as supply-side measures are usually business friendly which means that they will help firms
increase supply e.g. more govt training schemes might increase the supply of skilled labour to help businesses me rising
demand.

ECONOMIC GROWTH & ENVIRONMENTAL PROTECTION:

Growth & the environment: economic growth is often associated with environmental damage. As businesses produce more
output there are likely to be more emissions from power generators, chemical processors & other manufacturers. Also, sure
wealth and income that comes along economic growth means increasing numbers of people buy cars & other vehicles this
results in more emissions & increasing congestion on the road networks around the world. Pollution resulting from a food
business expansion is especially dangerous for health. Also, as more land is taken for business development less is available
for wildlife.

Possible trade-off
In developing countries, it’s unlikely that the majority of people would want to prevent economic growth that delivers less
poverty, longer life expectancy, lower infant mortality & improved living standards. Is in environment is damaged along the
way many people in these countries might argue that the price is worth paying. However, in some of these developing
countries, govts beginning to recognise that environmental damage can be costly & that measures are needed to protect
environment even if it means limiting business development.

INFLATION & THE CURRENT ACCOUNT ON THE BALANCE OF PAYMENTS:

Measures to reduce inflation: there is a possible link between inflation & the current account on the balance of payments.
When inflation is high & persistent, govts will try to reduce it because of the harmful effects associated with high levels of
inflation. If prices are rising, the price of exports will also be raising this will reduce demand for exports creating pressure on
the current account balance. It is also possible that consumers might switch from expensive domestic goods to relatively
cheap imports this would make the current account balance even worse. Consequently, high inflation rates have a damaging
effect on the country’s current account balance. If a govt uses monetary policy to reduce inflation, the balance of payment
situation could actually become worse this is because monetary policy that uses higher interest rates to reduce inflation
might strengthen the exchange rate. When interest rates are high, the demand for domestic currency might rise & drive at
the exchange rate. If this happens exports become dearer & imports are cheaper this would further create pressure on the
current account balance.

Possible trade-off
A govt trying to reduce inflation for raising interest rates may have to except the current account will worsen for a period of
time. Although, impact of price changes of the demand for exports & imports will depend on the elasticity of demand for
imports & exports. However, if a govt uses fiscal policy alone to reduce inflation, a worsening of the current account balance
may be avoided for example if the govt cuts spending &/or raises taxes, there will be a fall in demand in the economy with
no real direct set in the exchange rate. Therefore, the prices of exports & imports will be fairly stable & the current account
relatively unaffected. The use of supply-side policies to reduce inflation will also avoid a negative impact on the current
account. Supply-side policies aren’t likely to affect the exchange rate & also business friendly. As a result, businesses might
be able to produce more output at lower prices. This would help to boost exports & therefore benefit the current account.