ECONOMIC GROWTH

Benefits – More goods demanded, more jobs -> more employment -> higher standard of living.

Problems – gap between rich/poor may widen Growth may be in de-merit goods, e.g drugs Growth may be at expense
of environment

Increased demand for imports worsens aggregate demand

If demand rises faster than production capacity goods will become scarce. Leads to rise in prices, inflation

INFLATION

Rise in price of goods within economy. Reduces purchasing power of money each £buys fewer goods Governments want
low inflation because as prices consumers buy fewer goods, reduces growth, Under inflation, employees will push for
higher pay rises to match price rises.

Price of raw materials rising means reductions in investment and production. Consumer confidence may be damaged
due to uncertainty of goods and services. People on fixed incomes worse off.

High inflation in one country makes cheaper imported goods attractive, adversely affecting aggregate demand.

TRANSACTIONS MOTIVE – Those that save to spend later. These people will save less in order to avoid the purchasing
power of their savings being eroded

PRECAUTIONARY MOTIVE – Will save more as they will be uncertain how much money they may need in the future due
to rapid price rises.

STAGFLATION – Inflation rises rapidly while economic growth slows

BALANCE OF PAYMENTS

CURRENT ACCOUNT – Import and Export of goods and services

CAPITAL ACCOUNT – Net change in ownership of foreign assets, such as loans between governments and other
countries.

FINANCIAL ACCOUNT – Cash flows

We strongly focused on

TRADE DEFECIT – When a country’s imports exceed exports

TRADE SURPLUS – When exports exceed imports

FIsCAL POLICY – Government’s taxation and spending plans

MONETARY POLICY – Management of the money supply (currency in circulation) & interest rates

When it comes to fiscal policy, governments must plan each year for –

1. INCOME - Money government raises from taxes

2. EXPENDITURE - Total amount government needs to spend to provide services for population Most governments
prefer to run a BALANCED BUDGET. Sometimes a different approach is required:

BUDGET DEFECIT –

 Occurs when government spending is higher than government income.

 To fund government needs to borrow money (PSNCR – public sector net cash requirement)
 When running a budget deficit government is injecting more money into the economy than it is taking out – this
boosts aggregate demand and reduces unemployment
 Running a budget deficit is known as a EXPANSIONARY strategy
 Used when a ‘deflation gap’ exists.

BUDGET SURPLUS –

 Taking money out of the economy, reducing aggregate demand

 Government spending is lower than government income
 Known as a CONTRACTIONARY policy
 Used when inflationary gap exists in the economy (when aggregate demand is higher than the country can
supply)

MONETARY POLICY

EXPANSIONARY policy increases money supply in economy increasing investment and employment.

CONTRACTIONARY policy decreases the total money supply helping reduce demand and ease inflation. To
increase/decrease money supply, governments can -

RAISE INTEREST RATES – Increases cost of borrowing, so reduces investment helping reduce the level of aggregate
demand in economy

RESERVE REQUIREMENTS – Reduces the amount of money banks have available to lend, limiting the money supply.

Done by increasing the reserve requirement (amount of deposits banks keep as cash) Pushes interest rates up.

Economies Theory

CLASSICAL THEORY
• Suggests government does nothing. The economy naturally moves to an equilibrium point with full
employment.

• E.g. recession – pricing of products falls, leads to reduction in selling price of products. Increasing demand for
them -> leads to economic growth.

KEYNSIAN VEW (DEMAND SIDE)

• Governments need to manipulate the level of aggregate demand via intervention to meet equilibrium.

• Governments should borrow money and inject it into the economy (budget deficit) when growth needs to be
stimulated.

• Governments to increase taxes & run a budget surplus to slow economy if moving too fast

MONETARIST (SUPPLY SIDE)

 Return to classical view – equilibrium point where supply meets demand

 Economy does not find this because it is hindered by market imperfections
 Role of government is to remove imperfections, Inflation/govt spending and taxation/price fixing/minimum
wage legislation/regulation of markets/abuses of monopoly power
 Solutions known as ‘supply side’ economics focus on improving the supply of factors of
 production (easier for business to access labour, raw materials etc)

GROWTH –Policies to promote growth

 Running budget deficit-This is demand side appraoach(kenesian view)

 increasing availability of production factors- Supply side (classic monetarist )
 cutting interest rates- both demand side and supply side

Unemployment

 cyclical : occurs in ‘bust’ period of trade cycle, when aggregate demand in economy is too low to create
employment opportunities. Keynesians would boost aggregate demand by running trade off. Monetarists would
remove market imperfections.
 Frictional unemployment – short term as people move between jobs – not normally seen as a problem
 Structural – or technological unemployment occurs where there is a structural change in the economy. Change
in skills required/location of jobs. Keynesian policies have little impact here, monetarist policies more effective –
e.g. retraining schemes tax breaks for redeveloping old industrial sites, business loans.
 Real wage unemployment – Industries that are highly unionised. Union negotiations keep wages artificially high
by threat of strikes. Means the number of people employed in industry is reduced. Monetarist would seek to
reduce union powers and abolish minimum age agreements.
INFLATION

 Demand-pull - occurs when demand for goods and services grows faster than ability of economy to supply.
Keynesians would reduce aggregate demand through higher taxes, cuts in spending, higher inflation rates.
 Cost-push - Underlying cost of factors of product rise – goods more expensive to make, forcing manufacturers to
raise their prices.
 Imported inflation – countries with significant levels of imports. If national currency weakens, the cost of
imports rises, leading to domestic inflation
 Monetary Inflation – Increasing the money supply increases purchasing power of economy, boosting demand
for goods and services. If this expansion occurs faster than the expansion in the supply of goods, inflation can
arise. Monetarists would argue rates reduce growth in money supply.
 Expectations Effect – Occurs when businesses predict an increase in price of goods and services due to inflation.
To protect themselves in the future, wages and prices are increased early. Leads to an inflationary spiral – i.e.
inflation occurs because it is expected to.

BALANCE OF PAYMENTS

If the country has a deficit on its balance of payments, there is a net outflow of funds from the country- this is not
sustainable.

 Expenditure-reducing strategies – Government deliberately shrinks domestic economy to reduce demand for
imports. Via – contractionary monetary policy running a budget surplus.
 Expenditure-switching – Govt. encourages consumers to buy domestically produced products rather than
imports. Controls are placed on imports, subsidies, lowering of exchange rates.