Specification

Specification Amplification

1.1 Economic Objectives of the Government

government objectives methods of measurement and trends over time government objectives, conflicts and ethical

issues the welfare state and its alternatives

Candidates should understand the principal government objectives of economic growth, full employment, stable prices and balance of payments. Candidates should be aware of the methods available to measure economic performance, such as: inflation, economic growth, balance of payments, budget deficits and surpluses. Candidates should be aware that conflicts can arise when attempting to achieve these objectives and the links to equity and equality. Candidates should consider how ethical issues affect the achievement of government objectives. Candidates should be aware of the benefits and drawbacks of the welfare state and the alternative of individuals providing for themselves.

1.2 The Economy at Work

types of economy market failure externalities the concept of an economic cycle government revenue and expenditure fiscal policies monetary policies supply side policies.

Candidates should be aware of the differences between free market and mixed economies. Candidates should understand market failure as the inability of the market system to allocate resources efficiently. Candidates should understand externalities as the difference between social costs (benefits) and private costs (benefits), and apply the concepts in a relevant context. Candidates should be able to explain the characteristics of the economic cycle: boom, recession, slump and recovery. Candidates need to consider how the government collects revenue and its patterns of expenditure. Candidates should be aware of how the government can affect levels of income and expenditure through fiscal policies. Candidates should be familiar with the role of the Bank of England in controlling the level of demand. Candidates should be aware of the use of interest rates to control inflation. Candidates should be familiar with supply side policies such as: education and training, incentives to work and competition policy.

1.3 The Role of the European Union (EU)

the effects of membership of the EU the Euro the impact of EU enlargement on the UK.

Candidates should understand the significance of the EU as a Single European Market with a single European currency. Candidates should know the potential benefits and drawbacks of the UK joining the Euro. A detailed knowledge of the European Commission and European Central Bank is not required. Candidates should have an appreciation of the potential impact on the UK economy of EU enlargement.

Types of economy ­ Candidates should be aware of the differences between free market and mixed economies.

Free Market Economy

Economic activities only occur through private businesses They exist to make profit for their owners and will produce whatever

maximises profit. Competition between businesses keeps prices low & quality of goods high Consumers with sufficient incomes can buy what they want Governments exist but only to regulate laws

Benefits

Produced at minimum cost ­ no waste and inefficiency Quality is high due to competition Benefits exceed its cost ­ only required outputs get produced

Drawbacks

Businesses can monopolize market and won’t provide low price & high quality due to no competition

Consumers cannot afford vital products ­ more poverty and inequality.

Mixed Economy

Government participates in mixed economy. Government provides vital components ­ health and education Most developed countries have mixed economies, but the balance between

businesses and government differs from country to country.

Market failure ­ Candidates should understand market failure as the inability of the market system to allocate resources efficiently.

Monopoly ­ a lack of competition Public Goods ­ under producing some goods Merit and Demerit Goods ­ we make bad choices Externalities ­ we only consider ourselves

Market Failure occurs when markets fail to allocate resources efficiently

Prices or quantities of goods aren’t at the level that ensures economic welfare is kept

It can happen in three ways: I. It over/under prices a good/service II. It over/under produces a good/service III. It produces goods in an inefficient manner

Part 1 ­ Monopolies

A ‘pure’ monopoly exists when one firm supplies a specific good/service A monopoly company holds a dominant market position Economics are concerned with them as they ‘could’ abuse their power With less competition, less incentive to improve quality and keep prices low

Monopoly abusing its power:

Increases prices Reduces choice Lower quality of goods/service Operate inefficiently/not innovate

Barriers to Entry:

A firm will have come form of monopoly power if it has barriers to entry. It is something which potentially stops new firms challenging the existing

ones. Types of barriers to entry:

Legislature ­ Companies cannot start due to laws (eg. Etisalat) Loyalty ­ People are loyal to a company (eg. Apple, MS Word)

Capital Costs ­ Expensive to start (eg. Nuclear Reactors) Patents ­ Have intellectual copyright (eg. Microsoft) Immobility ­ Closer to customer (eg. Convenience store) Control of Supply ­ Have control of resource (eg. Saudi Aramco ­ Oil)

Why is monopoly a market failure?

Can inflate prices and make us pay more ­ reducing welfare Restrict supply to create scarcity ­ limits supply for us ­ reducing welfare Don’t have to be efficient as they can afford to lower costs ­ charge high price

as low competition

Part 2 ­ Public Goods

Public Goods are goods or services that are impossible to provide just for one

person The free market cannot adequately prove this Have certain characteristics which result in the market being unable to provide

such goods. Two characteristics:­

Non­Rival: If one person consumes the good, it doesn’t diminish the quality or quantity of another person to enjoy that good (eg. firework display, statue in a park)

Non Excludable: If one person consumes the good, other people cannot be stopped from enjoying the benefit of that good (eg. Army ­ national defense)

THE FREE RIDER PROBLEM (mainly non­excludable goods)

Some people choose not to pay for public goods others are willing to pay for Results in nobody paying for it and private businesses cannot profitably

produce the good The government provides the good and taxes it from people

The free market either under­provides or completely fails to provide public goods at a price considered socially acceptable. This is a market failure.

Part 3 ­ Merit and Demerit Goods

We don’t always make the right choices because we don’t see the bigger picture

We have imperfect information Merit Goods

We underconsume merit goods We underestimate the benefits We overestimate the costs

Eg. Education, healthcare Consumption of merit goods is believed often to generate positive

externalities­ where the social benefit from consumption exceeds the private benefit.

The government subsidises and passes laws to enforce these goods Demerit Goods

We overconsume demerit goods We overestimate the benefits We underestimate the costs

Eg. Cigarettes The government taxes and passes laws to reduce the consumption of

these goods

Externalities ­ Candidates should understand externalities as the difference between social costs (benefits) and private costs (benefits), and apply the concepts in a relevant context.

Part 4 ­ Externalities

Externality is a cost or benefit that falls not on the person directly involved in

the activity, but on others NEGATIVE EXTERNALITIES

Private costs are the costs the individual has to sacrifice External (Social) costs are the costs that others not involved in the activity

have to sacrifice POSITIVE EXTERNALITIES

Private benefit are things that individuals gain from their business/industry External (Social) benefit are the benefits gained by the society who aren’t

directly involved in the activity

Example: Opening a steel mill in a small town

Positive Externalities Negative Externalities

Private benefit ­ Produces steel (byproduct). Gains revenue External (Social) benefit ­ Can improve the economy of town, provides jobs & standard of living

Private costs ­ the costs/capital for starting the company or running costs External (Social) costs ­ There might be a lot of pollution and soot.

External Costs

These goods or service are underpriced and overproduced. The production or consumption of these goods/service don’t fully include all of

the external costs External Benefits

Jobs Extra spending

Better standard of living Improved facilities and amenities

These goods or service are overpriced and underproduced. The production or consumption of these goods/service don’t fully include all of

the external benefits. Dealing with negative externalities

Pass laws restricting activities of negative externalities (eg. In cities, you can’t burn trash)

Pass laws that target negative externality instead (eg. Steel mills required to have smoke stack to filter)

Impose costs, such as taxes on people/firms generating negative externalities (eg. Increase price of petrol → less cars → less exhaust)

Correcting Market Failure ­ TSNLE (Tax, Subsidise, Nationalise, Legislature, Education)

Tax

The government taxes the goods/services that are bad (negative externalities/demerit goods)

This causes the price to increase and steers consumers from buying or consuming this

(eg. cigarettes are taxed) Subsidise

The government subsidises the goods/services that are good (positive externalities/merit goods)

This causes the price to decrease and steers consumers into buying or consuming this

(eg. The government gives grants for students to attend university) This helps the government as:

Student goes to uni → becomes skilled/qualified → higher paying job (more skilled) → pays more taxes → revenue for the government

Nationalise The ‘draconian’ solution when the government takes over a company

Legislature

The government passes laws and regulations to avoid market failure Laws can be passed in favour or against companies

Education

The government can educate individuals to avoid market failure.

Government objectives ­ Candidates should understand the principal government objectives of economic growth, full employment,

stable prices and balance of payments.

Economic Objectives ­ BIGU (Balance of payments, Inflation, Growth, Unemployment)

Economic objectives are goals the government feels beneficial for the people and

country of achieved

Balance of payments ­ favourable balance of payments – to export more than we import

Inflation – Low and steady inflation ­ prices and wages fairly stable

Growth ­ Steady and sustainable economic growth (%change in GDP) – the economy to grow a little bit each year

Unemployment ­ Low unemployment – lots of people in work

Two other possibles:

Inequality ­ To reduce inequality in the country – to redistribute income and wealth in

order to help the poor

Environment ­ To protect the environment – to avoid pollution and congestion

Economic Growth ­ Steady and Sustained

It is where the productive capacity of the economy is increasing The indicator of growth is the change in real national income (GDP)

Increased Economic Growth → Increased standard of living

Governments want high growth

Adds national income → higher incomes → better standard of living

However if growth is too high higher consumer spending → rising prices → causes inflation

→ prices aren’t stable

Rate of economic growth influenced by: Labour supply Productivity of labour Productivity of Capital Investment of capital Technology Resource available

Government objectives, conflicts and ethical issues ­ Candidates should be aware that conflicts can arise when attempting to achieve these objectives and the links to equity and equality. Candidates should consider how ethical issues affect

the achievement of government objectives.

The welfare state and its alternatives ­ Candidates should be aware of the benefits and drawbacks of the welfare state and the alternative of individuals

providing for themselves. Governments aim for higher living standards but also aims for amount of equality ­ redistribute some income from those large amounts to those less fortunate ­ wealth

distribution. Benefits of Growth Higher living standards

Higher growth → higher income → people can buy more and high living standards Reduction of poverty

Help move poorer people out of poverty by providing opportunities for better living standards → help citizens to escape poverty.

Investments in Infrastructure Means the governments collect more tax revenue and therefore can afford to

spend more on priority areas improve education provision and encouraging access to education providing improved health provisions, including health education improved transport links ­ greater investments in public transport

Lower crime As growth rises, the crime in an area reduces as there is less incentive for crime to

be committed. Costs of Growth Environmental costs

Higher growth → higher output Higher factory output → higher pollution Also worse traffic congestion and unaffordable house prices

Inequality All won’t benefit equally

People who benefit the greatest earn above the average income, below the average income find incomes largely unchanged.

Income inequality may lead to a significant part of the population falling into ‘relative’ poverty.

Government attempts to reduce this through welfare state Conflicts with other economic objectives

Low inflation

High growth = high inflation / because growth and spending are closely linked Higher spending → higher prices in the economy / because resources are

fully used and become scare → higher prices Balance of Payments

Higher growth → trade deficit / because higher consumer expenditure and this means more imports are purchased

Only way to avoid is no economic growth and higher demand for exports. Welfare state is the financial or practical help for those who need the

most support. Benefits of Welfare State Poverty is reduced

Welfare state supports people in need from providing money to the unemployed and retirement funds for the elderly

This tries to avoids people falling into absolute povery Inequality is reduced

Welfare state is funded from people’s taxes. Highest earners pay heavy tax → provides income for poor families.

Narrows a gap between the rich and the poor → more equal distribution of wealth so less crime

Increases health of population NHS provides free healthcare

If it was all private, those on lower incomes might not receive full benefits and health

Health of population is linked with income Costs of Welfare State Removal of incentives to find work

Providing people will benefits removes incentive to find work Provide same level of income as low­paid jobs

Higher taxation Higher income people pay higher proportion of their incomes in taxes.

Alternatives to welfare state Increase the role of the voluntary sector

Charity sector can contribute and provide for those who rely on welfare state. Make benefits universal/ those meeting certain conditions

Child benefits ­ everyone gets it regardless of income. However it will cost more. To find if people have certain conditions ­ costlier administration

The concept of an economic cycle ­ Candidates should be able to explain the characteristics of the economic cycle: boom, recession,

slump and recovery.

Economic Growth ­ Economic Cycle

Period Economic Objectives Change Reason

Boom Economic Growth High/Rises

People are confident ­­> incomes rising. They are spending more

money. There is more borrowing and spending. Businesses will invest

more, seeking to expand.

Unemployment Low

Unemployment is low as businesses can expand and hire more workers as there is more demand for products

Inflation Rises

Inflation is rising as there is an increased demand for goods and

services, also demand for resources to produce those goods

Balance of payments Deficit/Worsens

Balance of payment worsens as people have more money to spend on exports and not imports. (Imports >

Exports)

Recession Economic Growth Falls Consumers don't spend as much

money as people start to save more

Unemployment Rises

Businesses might need to lay off workers as the demand for

goods/services decreases and the running costs increase.

Inflation Decrease

Inflation will decrease as the demand decreases with consumer spending

decreasing.

Balance of payments Better

People don't spend money on imports as much as before as it is expensive ­ they spend more on exports, causing

a surplus.

Slump Economic Growth Low/Negative

The consumer spending is low as they are pessimistic and insecure

about their jobs ­ losing it. They begin to save and don't buy goods.

Unemployment High

Businesses might cut of more workers as there is a decrease in

demand for products.

Inflation Low/Falling

Inflation is low as business try to create demand by decreasing the prices of goods, causing a demand

pull deflation

Balance of payments Surplus

With consumer spending low, people spend more on exports than imports,

causing a surplus.

Recovery Economic Growth Rises Confidence returns to the customers and businesses; consumers buy and

businesses invest more money

Unemployment Falls

As the demand increases with higher amount of consumer spending, the businesses can hire more workers to meet the higher demand, causing

unemployment to decrease.

Inflation

Stop falling/Rises

The inflation rises as the demand for goods increases. This causes the

prices to rise

Balance of payments Worsens People begin to spend on imports as they might receive higher wages.

Definitions Boom: A sustained period above trend growth Recession: It is two successive quarters of negative growth Slump: It is a sustained period of below negative trend Recovery: Two successive quarters of positive economic growth Flowcharts Recovery Consumers spend/save more → businesses can borrow to invest → higher production → higher aggregate demand → hire workers → lower unemployment → more wages for workers → can spend more → HIGHER ECONOMIC GROWTH Recession Consumers spend less → less aggregate demand → businesses don’t make profit → worker’s wages costs too much → laying off workers → unemployment increases → people save as they receive no income → decreases economic activity

Inflation

Inflation refers to a general and sustained rise in the level of prices of goods and services.

Most of the prices of goods (such as a loaf of bread) and services (like getting a haircut at the hairdresser's) keeps increasing.

Inflation changes the ratio of money towards goods or services; more money is needed to get the same amount of a good or service, or the same amount of money will get a lower amount of a good or service.

Government increases supply of money at the same rate as the growing demand for

money, prices don’t change Government increases supply of money at a faster rate as the growing demand for

money, prices increases ­ inflation Government increases supply of money at a slower rate as the growing demand for

money, prices decreases ­ deflation

How to measure inflation There are several ways that have been used to measure Inflation, the two main ways are by CPI and RPI. This index affects loans, wages, basic price of goods and many more.

A. CPI ­ stands for Consumer Price Index and measures inflation by the change in goods such as butter, yogurt, gas from the consumer's point of view. It calculates by comparing the cost with the previous year and finds out the proportional difference. However the CPI disregards home costs, thus creating a void in rises in mortgage and council tax, etc. Unlike the RPI, which calculates the proportional difference using arithmetic mean, CPI calculates it using geometric mean. The targeted CPI of UK is 2% and is prepared monthly by the Office of National Statistics. One of the reasons several governments don't shift to CPI is because the pensions and loans will be less compared to an RPI driven inflationary figures.

B. RPI ­ stands for Retail Price Index and gives a higher index than the CPI. It takes into account mortgage costs and has an effect on mortgage borrowing. Since the RPI has more to calculate (services), the RPI fluctuates much faster and is higher and lower than CPI. This makes RPI inaccurate. However it has been used predominantly due to its history of usage and a alteration to this can cause mass confusion. However the Treasury of UK argues to convert to the CPI as it would save a lot of money ­ pension money.

Causes of inflation A. Cost Push ­ This is mainly from the manufacturing side of the economy. The

significant sparks can be a rise in wages of workers or the rise in price of raw materials. This would lead to the business requiring to increase the price of its goods. The business would then want to increase its price again as it wants a higher margin of profit. All this would make the prices of goods and services increase.

B. Demand Pull ­ This is mainly from the consumer side of the market where the increasing demand for a good or service causes the business to force the price upwards. It can also be influenced by a legislation which can involve cutting taxes to a certain good or service.

C. Money Supply ­ This is the instance when there is a lot of money inside the economy of a country that the value of the currency depreciates due to its high circulation. An example of this would be during post WWI when Germany printed it's own currency and caused the value of the Reichsmark to depreciate, causing hyperinflation.

Impacts of inflation

A. Real Income ­ One of the serious effects of inflation can be that the 'real value' of an individual's income depriciates. The individual might receive the same income but if the prices keep increasing, the value of his income will go down. This can cause an individual to buy less quantity out of the same price.

B. Shoe Leather Costs ­ Inflation causes people to migrate from similar goods to another to get the best price/reward. They make visits to several places to get the best price (wearing out their leather shoes!)

C. Menu Costs ­ Increase of prices will cost firms to change their 'menu prices' for customers. This normally apply to business dealing with the sale of raw materials as they would be required to keep up with the prices demanded in the economy. For example, the price of gold can rapidly increase due to the rise in gold prices and the businesses would be required to change their 'menu'.

D. Wage Price Spiral ­ The workers demand a higher wage to combat the higher standard of living. For the business to maintain the profit margin as its unit labour costs have risen, it increases prices of its goods. This causes a repetitive cycle which gradually increases the prices of goods causing an increase in goods. This can be ineffective as this will cause a gradual increase in prices.

E. Savers and Borrowers ­ Inflation can be positive and negative for both savers and borrowers. Borrowers will benefit through inflation as they will see that the value of their debt has decreased. However it is detrimental for savers as the value of the money they saved has depreciated. This is the drawback of inflation as saving is looked upon as a 'moral activity' and it's something good; however people who save suffer. In Zimbabwe during the hyperinflation, the pensioners and savers suffered since the value they saved was insufficient to buy a handful of apples.

Balance of Payments

This balance of payments account records transactions between the UK and other countries

The current account is made up of: Trade in goods Trade in services Trade in incomes Transfers

Surplus is Exports > Imports Deficit is Imports > Exports UK is Bad In Goods ­ BIG Deficit UK is Good In Services ­ GIS Surplus What causes a deficit?

When income is high ­ consumers spend more on imports, volume of imports grows quickly

Many businesses in the UK have outsourced their production to other countries (as it is cheaper).

The UK is a net importer of foodstuffs and beverages. The trade balance is vulnerable to shifts in world commodity prices and

exchange rates. The UK imports a large volume of raw materials, component parts and pieces of capital equipment.

Government revenue and expenditure ­ Candidates need to consider how the government collects revenue and its patterns of

expenditure

Taxation

The government spends a lot of money (expenditure) to have economic growth. To finance this, the government raises money through taxation.

Types of taxes: I. Indirect tax ­ This is the tax imposed on businesses on expenditure. In the

UK, there is VAT (Value Added Tax). This is the tax which is imposed when a consumer buys an item/uses a service. This is for those individuals that don’t receive a known source of income (people who are paid without it being logged in the government system). Other sort of tax are tariffs, custom tax and excise duties (manufacturing products like petrol, alcohol and tobacco.)

II. Direct Tax ­ These are the tax that are imposed on the incomes of individuals. In the UK, income tax is the main direct tax by the government. In UK, there are two rates of taxation: the basic rate of 20% and the higher rate of 40% of income. National insurance is also a tax ­ businesses pay national insurance on every worker they employ. Other tax is corporation tax which is paid by companies on their profits.

III. Estate Tax ­ Also known as inheritance tax, this is the tax imposed on any inherited value (houses, money, etc.)

Government Expenditure

Social Protection

This includes welfare payments (unemployment benefits) and Jobseekers Allowance which are paid for those in need.

Some people are required to provide proof that they are currently seeking for a job

Some are paid in regards to their financial circumstances (people who have insufficient savings), but some are paid to everyone regardless of their status (child benefits are paid to all regardless of the family income)

Health Health spending is the largest component of government expenditure. NHS

provides treatment to anyone looking for it. As the UK population is ageing, the demands on the NHS are likely to rise for

the future

Fiscal Policy ­ Candidates should be aware of how the government can affect levels of income and expenditure through fiscal policies.

FISCAL POLICY ­ TBGS (Tax, Borrowing, Government Spending)

Fiscal policy concerns itself with how governments tax and spend. They are the decisions made by the government on its taxations and

expenditure. They have a major impact on economic performance and its ability to reach its

economic objectives. Fiscal policy is used by the government to manage the level of aggregate

demand for goods and services throughout the economy The Government Objectives:

Steady and sustainable growth Favourable Balance of Payments Acceptable unemployment Stable prices

Tools of Fiscal policy ­ TBGS Tax ­ This is the amount the government taxes from its citizens. They can adjust the tax ­

increase it and decrease it

Borrowing – The amount the government borrows from people ­ this is to fill the deficit

Government Spending ­ The amount the government spends on its citizens ­ welfare, on benefits and infrastructure building (building new roads ­ projects)

FISCAL POLICY → KEYNES (KEYNESIAN)

Expansionary: When the government expenditure is greater than tax. (GS>T) Contractionary: When the tax receipts are greater than government expenditure. (T>GS)

Expansionary (Spending > Tax)

Works by increasing demand. The government decreases the tax → people have more money to spend →

people buy items → businesses gain more revenue ­ invest → increases economic growth

Works by increasing government spending The government spends more money → people spend cause of positive

multiplier effect → People gain more income as people are spending more This will increase aggregate demand.

Contractionary (Tax > Spending)

Works by decreases demand. The government increases the tax → people have less money to spend →

people buy less items (they save) → businesses gain less revenue ­ invest less → decreases economic growth

Works by decreasing government spending The government spends more money → people spend cause of negative

multiplier effect → People gain less income as people are saving more This will decrease aggregate demand.

Expansionary (Spending > Tax) Deficit Contractionary (Tax > Spending) Surplus

Deficit ­ Government deals [spends more] Surplus ­ Government steals [taxes more]

Expansionary Contractionary

Economic Growth Increase Since there is less tax and

more spending, the people will spend more and this causes

businesses to grow

Decrease Since there is more tax and less spending, the people will save

more as they have less disposable income

Unemployment Decrease Since businesses will have higher revenue due to

increased spending, they can invest more and hire more people to meet the higher aggregate demand. Also

government spending creates more demand for output ­ more

workers required

Increase The decrease in spending from

consumers will cause businesses to lay off workers as there is a decrease in demand. This causes unemployment to rise. Higher tax can also cause a lower incentive to work ­ more money for the government and

not them?

Inflation Increase The increased spending means that businesses can push up

prices which leads to a demand pull inflation. Additionally, due to increased government

spending, inflation increases

Decrease The decrease in spending means that businesses will need to cut down prices to make the average consumer buy products ­ deflationary

Balance of Payments Worse Since people have more money to spend, they will buy imported

goods and less exports. However exports stay the same as the economic growth in other

countries affects this.

Better Since people have less money to spend, they will prefer to buy

exported goods and less imports.

Aggregate Demand Increase The aggregate demand will

increase as people spend more ­ causing the demand to

increase

Decrease The aggregate demand will

decrease as people spend less ­ causing the demand to

decrease

Multiplier Effect Positive Since the government is injecting money into the

economy, this leads to higher incomes for some people

meaning they will spend more.

Negative Since the government is

collecting money from taxes and it potentially decreases a person’s income making them

spend less.

Monetary Policy ­ Candidates should be familiar with the role of the Bank of England in controlling the level of demand. Candidates should be aware of the use of interest rates to control inflation.

Monetary Policy ­ IRMS (Interest Rates, Money Supply)

The policy which controls the supply or cost of money The Bank of England is responsible for setting the monetary policy It changes interest rates and money supply to stabilize and stimulate the

economy Most powerful policy to fight recession and reduce unemployment (more

powerful than fiscal policy) EURO countries lose their monetary policy (set by central bank in Strasbourg)

The Government Objectives:

Control Inflation ­ steady (issued by MPC) at 2% +/­ 1% Maintain sustainable economic growth Influence the Exchange rate

Tools of Monetary policy ­ IRMS Interest Rates ­ The central bank of a country issues an interest rate to other banks. In

UK, they are set monthly by the Bank of England. Money Supply – The amount of money circulating an economy/country at a given point

of time. The government can print money if there is a shortage.

Liquidity: It is the financial term which describes whether people have access to spendable

cash. Assets are able to be converted to spendable cash Less liquid assets take time to convert to spendable cash. It how easy it is to access cash (think frozen refrigerator! ­ the harder it is to get

back money ­ [saving money long term], the less liquid it is). Expansionary: When the government is trying to increase liquidity (Lowering Interest rates) Contractionary: When the government is trying to decrease liquidity. (Increasing Interest rates)

Expansionary (Increasing liquidity)

Lowering Interest Rates By lowering interest rates, the government encourages economic growth.

People start borrowing as the interest rates are low and spend it on items. This increase in consumer spending as there is more aggregate demand.

Business also take advantage of the low interest rates and borrow money to invest and grow their business. This spending causes economic growth.

Increasing Money Supply Increasing the amount of money available (printing money) causes people

to spend their money as they have an increased amount of disposable income. This causes the economy to “heat up” (as there is lots of economic activity). This causes inflation.

Increasing the availability of credit. (amount of loans you can take) This allows more people and businesses to take more loans so people

spend more and businesses invest more. Contractionary (Reducing liquidity)

Increasing Interest Rates People have mortgages → Increasing interest rates → people have to

spend more to pay mortgage monthly → less disposable income → spend less → less economic growth

Many high value purchases are based on credit (loans). If the interest rates increase, people tend to borrow less as their interest is higher. This decreases consumer spending

People tend to save money than borrow. Them saving money causes a decrease in liquidity as the ease of getting money decreases. People take advantage of the high interest rates in savings and tend to save.

Decreasing Money Supply Decreasing the amount of money available (printing money) causes people

to not spend their money as they have a decreased amount of disposable income. This causes the economy to “cool down” (as there is lower amounts of economic activity). This causes deflation.

Decreasing the availability of credit. (amount of loans you can take) This means that people are able to take less loans to buy expensive items

(new cars, houses). Additionally business cannot invest or borrow money.

Expansionary Contractionary

Economic Growth Increase Since the interest rates are low, people tend to borrow to spend on luxury items, etc.

Businesses can also borrow to invest and grow their company

Decrease The increase in interest rates

means that people are discouraged from borrowing as it’s deemed expensive. They take advantage of it and start saving money. People spend

less so this causes it to decrease.

Unemployment Decrease Since businesses will have higher revenue due to

increased spending, they can invest more and hire more people to meet the higher aggregate demand. Also

government spending creates more demand for output ­ more

workers required

Increase The decrease in spending from

consumers will cause businesses to lay off workers as there is a decrease in demand. This causes unemployment to

rise.

Inflation Increase The increased spending means that businesses can push up

prices which leads to a demand pull inflation. Additionally as there is more money in the

economy, prices can increase

Decrease The decrease in spending means that businesses will need to cut down prices to make the average consumer buy products ­ deflationary Also, since interest rates are high, people don’t borrow

money so prices go down to meet the demand

Balance of Payments Worse Since people have more money to spend, they will buy imported

goods and less exports. However exports stay the same as the economic growth in other

countries affects this.

Better Since people have less money to spend, they will prefer to buy

exported goods and less imports.

Aggregate Demand Increase The aggregate demand will

increase as people spend more ­ causing the demand to

increase

Decrease The aggregate demand will

decrease as people spend less ­ causing the demand to

decrease

Multiplier Effect Positive Since money is being spent into

the economy, this leads to higher incomes for some people meaning they will spend more.

Negative Since money is being saved in banks rather than being spent,

it potentially decreases a person’s income making them

spend less.

Value of Pound Decrease Due to lower interest rates,

people don’t save in UK banks but spend it. If saving, they save in foreign banks as they have better outcome. The value of the foreign currency will increase in relation to the

pound. This makes it cheaper for tourists to visit the country. Import of tourism decreases

(expensive) Export of tourism increases (less expensive to visit UK)

Increase Due to the high interest rates, people want to save in the UK (they can only save in pounds). This causes the value of the pound to increase as more

demand. Makes it cheaper for britishers to tourist

Import of tourism increases (cheaper)

Export of tourism decreases (more expensive to visit UK)

Higher interest rate: High Interest → Pay more taxes → less disposable income → spend less → businesses don’t get demand → lay off workers → unemployment increases → reduce price → deflationary → lower GDP Lower interest rate: Low Interest → Pay less taxes → more disposable income → spend more → businesses more aggregate demand → more workers cause higher output → unemployment decreases → increase price → inflationary → higher GDP

Supply Side Policy ­ Candidates should be familiar with supply side policies such as: education and training, incentives to work and

competition policy. Supply side policy ­ B4B

(Better ‘4’ Business)

The policies which raises the rate of growth of output without boosting spending are known as supply­side policies.

Successful Supply Side policies allow the economy to grow faster without inflation.

The types of supply side policies: (Supply side ­ all about productivity)

Education and training Educating the people increases productivity → higher national output More specialised → better standard workforce Reforms:

Educational maintenance allowance (EMA) grants people to ‘stay on’ education until they are 18

Number of university students have increased significantly National vocational qualifications (NVQs) encourage workers to

undertake work­based training Policies to encourage long term unemployed to start training

Better Research and Development Innovate → More productivity

Competition Between businesses → higher output levels → lower prices (reduce

inflation) Government will aid small businesses Less competition → less incentive to become better

Labour market policies If government increases benefits (Spending ­ Expansionary) → harder

for businesses to get workers → workers become complacent as they have high benefits.

Decreasing direct taxes on workers → firms can recruit more workers as they are more willing to work

Deregulation Means removal of legal restrictions that restrict business This makes things less complicated for businesses ­ less legislation

Easier hire and fire People work in more productive places

Reforming Tax Can affect businesses and workers Improves incentive for workers and business → don’t need to save

much Higher taxes for businesses (Bad):

Invest less ­ it is expensive to borrow money Lay off workers ­ the costs of production might be too high and

need to cut costs Move country ­ as it is cheaper to produce in other countries

The effects of membership of the EU ­ Candidates should understand the significance of the EU as a Single European Market

with a single European currency.

European Union

It has 27 countries that co­operate together on economic and political issues. It began in the 1950s as an agreement between 6 countries to engage in free

trade (UK joined in 1973) EU is a large organisation that contains almost 500 million people, has its own

parliament and set rules and regulations across each member country.

Benefits

Tariff­free trade Tariff are taxes placed on imports designed to encourage people buying

country produced goods. Can get goods cheaper There is external tariff (goods outside the EU) → encourage people buying

goods from the EU Higher incomes from greater trade

“if goods don’t cross borders, soldiers will” Nations who trade don’t go to war → war is expensive

Protectionism Protects EU businesses to thrive as people tend not to buy imported goods

(as they are expensive). It limits the threat of foreign competition. However not too much tariff as companies will not have the drive to improve

performance. Larger market for businesses, larger choice for consumers

500 million people in the EU compared to around 60 million people in UK. There is a larger market for trade.

Free movement for citizens in EU (Single European Market) It is easy for people to move to another country and get a job Money can also move freely between countries in the EU with no barriers to

transfer All goods provided in the EU have to conform to the same health and safety

standards. Drawbacks

Richer states have to pay for the development of poorer states During recession when countries economies were unstable.

Payment for Common Agricultural Policy (CAP) UK is a net contributor for CAP

Influx of people from new EU countries Incomes are higher in UK ­ better standard of living Schools with non­english speaking students (might retard education)

More regulations from EU on business Businesses might need to cut profits.

The EU on the UK: Benefits

Greater choice for customers Customers have a wider choice of goods as there is more trade that UK is

involved in (free trade). All these goods should be available without tariffs.

Larger market for businesses This is an opportunity for businesses to expand its reach as now they are

open to a market with 500 million people (popn. of the EU) compared with around 60 million (popn. of UK)

They have greater demand and higher sales. Higher Incomes

Countries can specialise in production (due to free trade) and they are more skilled at producing what they are good at.

Political influence

Have various powers to influence policy. Non­EU countries don’t have these in guiding the future of the EU.

Drawbacks

Competition for UK firms UK firms have to compete with other firms The costs can be lower for these UK firms (due to cheap wages) It can be harder for UK firms to compete successfully.

Lack of freedom UK businesses have to make sure that their products are up to EU health

and safety standards → costs money and time. Common Agriculture Policy (CAP)

UK spends a lot of money for this policy It ensures that farmers can get a guaranteed income for their output. This

benefits countries where agriculture industry is insufficient. UK farmers lose out as they are far more efficient than the other EU

member countries (that have a lower GDP).

The Euro ­ Candidates should know the potential benefits and drawbacks of the UK joining the Euro.

Euro

The Euro was planned for many years but was only launched in 1999 The treaty in 1992 paved the way for a full monetary union through the

creating of the euro. It currently has 18 countries (as of 2014)

Benefits

Reduced transaction costs There are no costs involved in converting one currency to another Businesses trade with other countries they incur a high trade cost

Uncompetitive exports As there is only a single currency, it is easy to export and import and reduce

problems Ease of price comparisons

There is transparency in prices of the same products in different places Greater economies of scale

Greater trade with other countries in the eurozone. This has allowed firms to expand and increase efficiency

Drawbacks

Costs of preparation It is expensive to train individuals and staff on its dealings about the

switchover. General population will also need to be educated in how the new currency

works Loss of control over interest rates

The country loses its monetary policy as it is set by the European Central Bank which applies for all banks in the eurozone

Member state’s fiscal policies are constrained Use of exchange rate

Allowing the exchange rate to fall boosts economic growth as it increases a country's exports (as it is more desirable). This isn’t possible in a single currency

Why is the UK not in the Euro

UK promised to give the citizens a vote in the future, until then it is not part of the Euro.

Believed that UK and Euro economies are different ­ the interest rates will clash. Less pro­European than most other EU countries

Impact of EU enlargement on the UK ­ Candidates should have an appreciation of the potential impact on the UK economy of EU

enlargement. EU Enlargement

Since 2004, 12 countries have joined the EU

Effects of expansion

Cheap labour costs As many eastern countries are not highly developed, businesses can

move here and can reduce their costs Greater competition

There will be greater competition for western countries with the influx of new eastern countries.

More choice for consumers Due to the absence of tariff, the people can get goods from different

countries of the EU for a reduced price.

Candidate Countries 1. Albania 2. Iceland 3. Montenegro 4. Serbia 5. Macedonia 6. Turkey

Candidate countries Benefits

Increase GDP Better for businesses in Turkey (increased market) Increased international trade (foreign Investment) Increased competition Decrease Unemployment

Created job opportunities People can move

Foreign Investments New joining countries have low wages ­ businesses open here as it is cheap

Drawbacks

Dilution of culture

Loss of skilled workers Loss of local business Sign up with Euro

Loose monetary policy Member countries Benefits

Large consumer market Lower wages Variety of Culture Greater variety and products available

Drawbacks

Increasing unemployment Pressure on infrastructure.

POVERTY Notes 1 What is poverty ­ Poverty is linked directly to standards of living. People in poverty are expected to have significantly reduced standards of living. Poverty is broken down into two main types. Measurements of standard of living­ ­GDP per capita ­measures the total amount of goods + services produced per person adjusted for inflation ­ tells us how big each person's share of GDP would be if divided into equal portions ­ GDP ^ = populations Standard of Living ^ Problems­ unpaid wealth(moms,charities), different distributions of wealth(not equal$, changes in quality of life Problems­ GDP may be rising but if cost of living increases at greater rate then SoL could fall (cuz economic growth+incomes ^ = inflation ^ = harder to spend as much) ­Household income + wealth ­median household income ­ good indication of typical' households income ­ median income ^ = SoL ^ Problems­ income may be rising but if cost of living increases at greater rate then SoL could fall (cuz economic growth+incomes ^ = inflation ^ = harder to spend as much) Level of education Problems­ less educated could still be working and more educated could decide to not work and stay on benefits Standard + level of health Problems ­ —GDP per capita and household incomes may both be rising but if the cost of living increases at a greater rate then standards of living could fall –indeed whilst economic growth and incomes have slowly risen, the high rates of inflation have squeezed budgets! — Causes of poverty­ Unemployment Illness Lack of skills and qualification Lack of education Age Debts Government policy(benefits and minimum wage) ­ if benefits high, the incentive to work will be lower and so people fall into relative policy. Also there might be less incentive to hire workers which will lead to jobs being cut Economic transition ­ House boom (Prices raise ­ homelessness rises)/ Industrialisation (supply of jobs less than demand for them ­ jobs close down/more low paid jobs)/ Less support Relationship breakdown ­ depression. or being single makes it harder to work due to having to take care of kids (child care too expensive) Child poverty ­ poverty begets in poverty (poor born poor) ­ won’t get many qualifications ­ less aspirations ­ leads to poverty for them in the future Consequences/Effects of poverty­ Poverty has effects on:

Individuals ­ Standard of living decreases, Joblessness, Poor health (mental and physical), Poor educational attainment

Groups ­ Standard of living decreases, Inequalities in income

Society ­ Poorer economy/Lower GDP, Social problems (Crime, Unemployment, Illiteracy, Hunger, Discrimination)

Impacts of poverty on the UK economy­ In a market economy an individual’s ability to consume goods & services depends on their income or other resources (e.g. savings) An unequal distribution of income and wealth may result in an unsatisfactory allocation of resources and can also lead to alienation and encourage crime with negative consequences for the rest of society The free­market system will not always respond to the needs and wants of people with insufficient economic votes to have any impact on market demand. What matters in a market based system is your effective demand for goods and services. Solutions to poverty­

Subsidies to firms that start in poorer areas so more people have job opportunities and jobs are created in places with high unemployment rates to reduce them

Changes in tax and benefits system to favour those (working) on low income to keep them working and motivated ­ tax the richer and redistribute to the poorer (not only the unemployed)

Increase national minimum wage so people want to work as they will be getting more money

Improve training and educational programmes so people can get more qualification and work in better paid jobs (specially for the unemployed and those in low paid jobs)

Ethical considerations/dilemmas­

Relative poverty will always be there no matter what (has to be a difference in incomes) Absolute equality in incomes is not desired, fair or possible (some people will always work

harder, better and more than others and should be paid more Government should question who to give benefits to all as it can discourage people from

working if it is easy to claim benefits ­ where and when should they give them and where and when shouldn’t they? ­ who should they give them to?

Government should question if it is right to force people to work ­ own individual right and decision

Government should question if it is ok to have poverty or not and if it is correct or not to give support ­ Have they taken the wrong decision themselves?

Government should consider whether to prioritise children, adults or retired/pensioners in poverty (who should they give support to) and how

2 marker Identify/define/list/Indicator 4/6 marker Causes and Consequences 12 marker Solutions People often say the unemployed(those on benefits) are parasites ­ the fact that companies are parasites as they are not paying a minimum wage.

Poverty Notes 2 The Meaning of Poverty Poverty is linked directly to standards of living. People in poverty are expected to have reduced standards of living. Two Main Types of Poverty: Absolute: Absolute Poverty: Is when individuals do not have access to the basic requirements of life – food, shelter, clothing (needs)

1. Absolute Poverty: Even in developed countries like the Uk there are some who can’t afford basic needs.

10.6 million People in absolute poverty, up from 9.7 million in 2012. 62% rise in absolute poverty between 2010­2012 The number of children living in absolute poverty has risen from 3.6 million in 2012, to 4.1 million in July of 2014 2. Relative Poverty: A situation where individuals are excluded from being able to take

part in what are acceptable standards of living in society. They are said to have lower income relative to other groups in society.

For example: may have somewhere to live and food to eat but may not be able to pay the bills of buy new clothes. Relative poverty varies between regions in the Uk and over time. Someone who is relatively poor in London may be rich in Middlesbrough. If a country experiences a rise in income absolute poverty may fall however those with higher incomes benefit more and relative poverty may rise.

Measuring Relative Poverty­ people considered relatively poor are defined as having income less than 60% of the average income. Medium average income was 427 pounds per week before housing costs. 60% of £427 is equal to £256 per week before housing costs which is the threshold below which people are considered to be in relatively poverty. Latest government statistics indicate there are 2.3 million (17%) children, 5.6 million (15%) working adults and 1.9 million (16%) pensioners, all living in relative poverty

Measurements of Standard of Living

1. GDP per capita­ GDP per capita adds up all the goods and services produced in the UK and divide it by the number of people in the population. If GDP per capita increases then the UK population is said to have a higher standard of living. Therefore Real GDP per capita measures the total amount of goods and services produced per person adjusted for inflation. Problems with this method: 1. Unpaid work —Real GDP per capita doesn’t acknowledge the value of housework, in­home child care, in­home elder care, volunteer work, and community service. 2. Distribution of wealth — there is always the possibility that a large share of the gains in real GDP per capita will go to a relatively small percentage of the population. In the past increases in GDP were also more likely to be unequally distributed along gender, racial, and ethnic lines. 3. Changes in the quality of life — Real GDP per capita doesn’t fully account for the value of things like clean air, clean water, more leisure time, and increased life expectancy; nor does it fully account for the cost of such undesirable changes as increased traffic congestion or loss of open space.

2. Household income and wealth­ Many economists argue that growth in median household incomes provides a better measure of how the standard of living has changed over time. The median household income is the income of what would be the middle household, if all households in the UK were sorted in a list from poorest to richest. As it represents the middle of the income distribution, the median household income provides a good indication of the standard of living of the “typical” household in terms of income. It follows that higher

household income and wealth will mean higher standards of living because individuals and families will be to afford the goods and services deemed necessary for an acceptable standard of living As with previous measures of living standards, using averages can be deceiving e.g. cost of living differences between London and Middlesbrough will mean that the income required to have an adequate standard of living will be different in the two areas. Another issue is that some people may receive benefits in kind. For example those on means tested benefits often receive prescriptions and dentist visits for free; therefore, their living standards are better than their actual income may suggest.

3. Level of Education and Standard of Health ­ A person’s standard of living can also be defined by their level of education and health, or their access these basic services. With greater qualifications and improved health an individual has a greater earning potential; and therefore is able to afford the goods and services required to achieve a high standard of living

4. General Problems­ Many indices are averages for the whole population of a country. This means that indices do not always reveal substantial inequalities between different segments of society. For example, a portion of the population of the UK could be living below the poverty line. In the data used in indices could be out of date or hard to collect. Some countries do not wish to have certain index data collected ­ for example, many countries do not publish statistics about the number of immigrants and migrants. GDP per capita and household incomes may both be rising but if the cost of living increases at a greater rate then standards of living could fall –indeed whilst economic growth and incomes have slowly risen, the high rates of inflation have squeezed budgets Life expectancy ­ the average age to which a person lives, eg this is 79 in the UK and 48 in Kenya. Infant mortality rate ­ counts the number of babies, per 1000 live births, who die under the age of one. This is 5 in the UK and 61 in Kenya. Poverty ­ indices count the percentage of people living below the poverty level, or on very small incomes (eg under £1 per day). Access to basic services ­ the availability of services necessary for a healthy life, such as clean water and sanitation. Access to healthcare ­ takes into account statistics such as how many doctors there are for every patient. Risk of disease ­ calculates the percentage of people with diseases such as AIDS, malaria and tuberculosis. Access to education ­ measures how many people attend primary school, secondary school and higher education. Literacy rate ­ is the percentage of adults who can read and write. This is 99 per cent in the UK, 85 per cent in Kenya and 60 per cent in India. Access to technology ­ includes statistics such as the percentage of people with access to phones, mobile phones, television and the internet. Male/female equality ­ compares statistics such as the literacy rates and employment between the sexes. Government spending priorities ­ compares health and education expenditure with military expenditure and paying off debts. Causes of Poverty:

Unemployment­ In December 2013, the UK unemployment rate was 7.4%. The individuals willing and able to work but the unemployed can find themselves in relative poverty. A single adult aged over 25 receives only £71.70 per week in Jobseekers Allowance. This is well below the 60% threshold of the average medium income of the UK £256 per week. With any other source of income the unemployed will be in relative poverty­ however these individuals may be in

receipt of the other government hand outs. Leading to Loss of skills, family breakdowns, poor health and mental issues.

Lack of Qualifications­ The lower a young adult's qualifications; the more likely they are to be lacking paid work (either unemployed or economically inactive). All levels of qualifications from GCSE to Degree appear to make a noticeable difference. Also the lower a young adult's qualifications, the more likely they are to be in low­paid work. All levels of qualifications appear to make a noticeable difference compared with the level below. The overall conclusion is that staying on in education post­16, and preferably post­18, is important, in terms of both

getting work and, if in work, getting a reasonable rate of pay. Illness and Disability­ Individuals suffering from illness or disability (physical or learning) are less

likely to find and hold down employment, leading to poverty. Those born with a long­standing illness or disability are also more likely to have fewer qualifications or experience which means that should they find employment it is likely to be low paid or part­time. Around a third of all disabled adults aged 25 to retirement age are living in low­income households. This is twice the rate of that for non­disabled adults, as it has been throughout the last decade. Unemployment, especially long­term, can lead to the risk of developing mental illness; indeed those in poverty are more likely to develop mental illness

Age­ Age is often a factor which indirectly causes poverty; age is normally combined with another factor to explain causation. Increasingly those adults aged 16 to 24 are in low­income households (1.7 million); with youth unemployment remaining close to the one million mark it’s not surprising that they find themselves in poverty. At any age being a lone­parent is one major cause of poverty; having to balance the care and financially responsibilities of a parent can mean you slip into poverty. Indeed 80% of lone parents in low­income households are aged 25 or older, with only 20% being under 25. Of the 1.6 million adult aged 34 to 42 in low­income households, 1 million are in families where someone is working (low pay?) and most of these are couples with children. At 45%, working couples with children are a much greater proportion of the adults aged 34­42 in low­income households than that for any of the other age groups. Of the 1.2 million adults aged 52 to 60 in low­income households, 600,000 have a disabled

adult in the family and most of these are workless. At 35%, workless families with someone who is disabled are a much greater proportion of the adults aged 52­60 in low­income households than that for any of the other age groups

Debt­ many who are in poverty are in arrears with their bills. 20% of workless families are overdue in their bills. The bills are mostly Council Tax, water, electricity and gas. Thise on low incomes turn to short term lenders and buy household items on hire purchase where the interest rates and the total amount repayable are high.

Government Policy­ Disability benefit has been cut and reformed; some have lost their entire benefits. Council homes have been sold off which means that many people are stuck on the waitlist. Public Sector jobs and wages are cut, less public sector workers mean less support for people to access to help them out of poverty.

Economic Transition­ Deindustrialization­ there used to be a great many jobs like mining which have disappeared. This means that the supply of labor is greater than the demand. Leading to more service jobs that are lower paid. Housing Boom­ Between the late 80s and mid 2000 house prices raised. Making home owners rich. It means that people who do not own a house are unable to afford one.

Lack of Information­the lack of take up of benefits which adults are entitled to; this may be due to lack of information or ignorance. Around 40% of all pensioner households entitled to Council Tax Benefit are not claiming them. (1.7 million households) 33% of all pensioner households entitled to Pension Credit are not claiming it (1.3 million Households

Discrimination­ Blacks are more likely to be in poverty than whites in UK. Women are more on Lower pay. Those people with disabilities but able to work are more likely to be unemployed than non­disabled people.

Relationship Breakdown­ causes poverty for women and children as women more likely to keep the children. Single parents are less well off.

Child Poverty­ children born in poverty are likely to stay in poverty. Less access to education. Lower aspirations. More likely to suffer abuse and become damaged by it.

Effects of Poverty: Effects on individuals: Poor Educational Attainment.

Joblessness Poor Physical health Mental health (Stress levels are elevated due to poverty; high blood pressure; poor nutrition)

Effects on Groups: Inequalities in income Living Standards

Effects on Society: Social problems (high crime, high unemployment, illiteracy, hunger and discrimination)

Solutions to Poverty: National Minimum Wage Changes to the taxation and benefit system to favour those on low incomes improved training and education programs

As the causes of poverty are so diverse and different, any solution to tackle UK poverty will have to consist of a range of policies and government interventions.

As such you should include this consideration in response to this type of question, should it be asked in the exam (see the example of a concluding paragraph below)

“I believe that the most effective solution to tackle UK poverty is to increase the NMW so that it becomes a ‘Living Wage’, enabling those in income poverty to achieve an acceptable standard of living. However the fact that poverty is a consequences of factors other than low income (such as illness, increased cost of living and debt), any solution to tackle poverty will have to include a range of measures, used in combination with a policy to raise the NMW.”

Ethical Solutions of Poverty: Ethics are the ‘rights’ and ‘wrongs’ of an issue So the ‘ethics of solutions’ to tackle poverty refers to what we feel is right or wrong when trying to solve it.

You may be asked a direct question about ethical solutions to tackle UK poverty – if so then put forward your most ethical solution and compare it with the less ethical ones (i.e. raising the NMW and improving education and training may be more ethical than increasing government benefits such as JSA)

If you are asked an exam question asking for any solution(s) to UK poverty then bring in your ethical considerations ­ it would enhance your evaluation mark and concluding paragraph (see example of a concluding remark below)

….“whilst raising benefits would ensure the unemployed, sick and disabled would have sufficient household income to achieve an acceptable standard living, ethically is it right to provide financial support as it can discourage the jobless population to find employment (i.e. the benefits trap).”