Subject: Economics Topic: The economic cycle Year Group: 12

Circular flow of income Factors affecting AD and AS

The economic cycle
1 The circular flow of income and spending shows connections between different AD AS
The economic cycle is the fluctuation of the economy sectors of an economy
between periods of expansion (growth) and contraction The aggregate demand curve tends Employment costs e.g. wages,
2 It shows flows of goods and services and factors of production between firms and to shift to the left when total employment taxes. Unit labour
(recession). Factors such as gross domestic product (GDP),
households consumer spending declines. costs are also affected by the level
interest rates, total employment, and consumer spending, Consumers might spend less of labour productivity
can help to determine the current stage of the economic because the cost of living is rising or
3 The circular flow shows how national income or Gross Domestic Product is
cycle. calculated because government taxes have
increased.
4 Leakages (withdrawals) from the circular flow
A large rise or fall in the exchange Costs of other inputs e.g.
Not all income will flow from households to businesses directly. The circular flow
rate – affecting export demand and commodity prices, raw materials.
Characteristics of a boom and shows that some part of household income will be:
second-round effects on output, The exchange rate can affect the
[Link] aside for future spending, i.e. savings (S) in banks accounts and other
recession types of deposit
employment, incomes and profits
of businesses linked to export
prices of key imported products
[Link] to the government in taxation (T) e.g. income tax and national insurance
BOOM RECESSION industries.
[Link] on foreign-made goods and services, i.e. imports (M) which flow into
the economy An unexpected cut or an Impact of government e.g.
When the economy is in When the economy is in unexpected rise in interest rates or environmental taxes such as carbon
5 Injections into the circular flow are additions to investment, government
expansion, businesses contraction/recession, change in government taxation and duties & business regulations which
spending or exports so boosting the circular flow of income leading to a
generate profits, which businesses lose profits, spending – for example deep cuts in affect the costs of production
multiplied expansion of output.
government spending as part of
leads to hiring more which leads to downsizing
fiscal austerity
employees, and more and laying off of Capital spending by firms, i.e. investment expenditure (I) e.g. on new
disposable income and employees. When technology An event such as the credit crunch Natural disasters can have a
spending. It, in turn, leads to employees lose their jobs, The government, i.e. government expenditure (G) e.g. on the NHS or defence (global financial crisis) – involving a negative impact on an economy’s
more profits for businesses, there is less disposable Overseas consumers buying UK goods and service, i.e. UK export expenditure fall in the amount of credit ability to produce goods and
(X) available for borrowing by services.
and it continues in a income and less consumer
households and businesses.
virtuous cycle. spending, which leads to 6 An economy is in equilibrium when the rate of injections = the rate of
even lower business withdrawals from the circular flow. A slump in the housing market or a Improvements in productivity can
profits. It continues in a big change in share prices shift the aggregate supply curve to
vicious cycle. the right

What is Aggregate Demand? A recession in main trading partners

affecting demand for exports of
Aggregate demand is the total demand in the economy. Total demand comes from goods and services.
What is Aggregate supply? households, businesses, government and from abroad. It can be summarised with this
equation: Ad = C + I + G + X - M
Aggregate supply measures the volume of goods and services
produced each year. AS represents the ability of an economy to deliver
goods and services to meet demand
 Subject: Economics Topic: The economic cycle Year Group: 12

Measures of unemployment Employment, underemployment and unemployment Causes of unemployment

The claimant count is a measure of unemployment and counts 1 Employment refers to the number of people in work Structural unemployment occurs because the
only those people who are eligible to claim the Job unemployment structure of the economy has changed; for
Seeker’s Allowance (JSA). One significant problem with the example, the decline of whole
2 Unemployment refers to those who are willing and able to work but unable to
claimant count is that it omits many people who are interested industries such as coal mining.
work
in finding work but do not meet all of the criteria for claiming.
Occupational when an unemployed person does not have
3 Underemployment is defined as a situation where people are working fewer immobility the right skills or abilities to take up the
The ILO measure is designed to include all persons above a
hours than they wish; e.g. you would like to work 40 hours a week, but the firm
specified age who are, without work, currently available for employment on offer, this is often
only gives you 30 hours.
work and seeking work. linked with structural change.
Underemployment may also refer to the fact workers accept jobs that don’t Geographical similar in that an unemployed person is
utilise their skills. e.g. graduate working in McDonald’s may be considered to be
Impacts of unemployment ‘under-employed’)
immobility prevented from taking a job because they
cannot move to where the job is,
1 Loss of income for unemployed which leads to lower perhaps because of family or the cost of
consumption moving.
What is Aggregate Demand?
2 Less tax revenue for government and higher government
Aggregate demand is the total demand in the economy. Total demand comes from
Technological caused by technological change. As
borrowing, budget deficit unemployment technology improves it is often the case that
households, businesses, government and from abroad. It can be summarised with this
equation: Ad = C + I + G + X - M fewer employees are needed,
3 Potential homelessness. Loss of income can leave people they can be replaced with machinery or
without sufficient income to meet housing costs. Rises in
computers.
unemployment often exacerbate the rates of homelessness.
What is Aggregate supply? Demand-deficient also known as cyclical unemployment is
4 Lost human capital. If people are out of work, they miss out on
‘on the job training’ This is a vital component of human capital Aggregate supply measures the volume of goods and services produced each year. AS unemployment where unemployment occurs because AD in
and labour skills; high rates of unemployment can reduce represents the ability of an economy to deliver goods and services to meet demand the economy has fallen (in a
labour productivity. If someone is out of work for two years, recession), leading to a fall in the demand
they miss out on the latest working practices and trends. for labour.
Being unemployed can also affect the confidence of the
Inflation
unemployed and they become less employable in the future. 1 Inflation is a sustained rise in the average price level (usually retail prices) and a
5 Harms future prospects. Those who are unemployed will find fall in the value of money. RPI AND CPI MEASURES OF INFLATION
it more difficult to get work in the future (this is known as the RPI includes the costs of housing (mortgage interest costs and
hysteresis effect) 2 Deflation is a sustained fall in the average price level (usually retail prices) and a
rise in the value of money. council tax for example) while CPI does not.
6 ower GDP for the economy. High unemployment indicates the
The RPI is an arithmetic mean ie, the prices of everything to be
economy is operating below full capacity and is inefficient; 3 Disinflation is a fall in the rate of inflation – a decrease in the rate at which the
this will lead to lower output and incomes. The unemployed average price level is rising.
included in it are simply added up and divided by the number of
are also unable to purchase as many goods, so will contribute items.
to lower spending and lower output. A rise in unemployment COMMON MISTAKE: disinflation does not mean a fall in the average price
The CPI is a geometric mean. It is calculated by multiplying the
can cause a negative multiplier effect.
prices of all the items together and then taking the nth root of
them, where 'n' is the number of items involved.
Real vs nominal values Demand pull and cost push inflation
The nominal value of something is its money value at different Demand-pull inflation occurs as a result of increasing AD in an Impact of inflation
points in time. economy, resulting in prices rising as consumers try to buy
increasingly scarce goods. Firms Households
Real values adjust for differences in the average price level over
time. In other words, real values are nominal values but with Cost-push inflation occurs as a result of an increase in the costs Uncertainty Fall in real income
inflation taken into account. of production in an economy, resulting in rising prices as firms
try to maintain profitability. The rising price of oil and other Higher costs of production Less purchasing power
imported commodities can cause cost-push inflation. Loss of competitiveness Uncertainty about future prices
Fall in demand due to Pensioners, savers and those on
households spending falling and fixed incomes lose out
lack of competitiveness
Borrowers benefit as inflation
erodes the real value of their
debt