Macroeconomics Homework 1

a) Unemployment A situation where people are out of work but willing and able to work
Economic Growth In the short run economic growth is an increase in real GDP and in the long run it
is an increase in productive capacity (an increase in the maximum output that the economy can
produce)
Sustainable Economic Growth Economic growth that can continue over time and does not endanger
future generations ability to expand productive capacity
Inflation A sustained rise in the price level; the percentage increase in the price level over a period
of time
Low and Stable Inflation A sustained increase in the general price levels at a low and consistent rate
(around 2 percent)
Income Distribution How income is shared out between households in a country
Balance of Payments A record of money flows coming in and going out of a country
B)
1) Low unemployment is important for a number of reasons. Firstly, there is a cost to the
economy in terms of wasted unused resources; consequently, the economy will be at a point
within its PPF and therefore not working at full potential so there is a decrease in output.
Secondly, the lower the levels of employment, the higher the government benefit roll and the
smaller the governments income tax revenue so it is a governments advantage to avoid
bearing these costs. As well as this, unemployed people are potentially more likely to commit
crimes (due to boredom and a lack of income) which would create further governmental
costs.
2) Stable and sustainable economic growth is important because greater economic growth
leads to improved living standards which is beneficial for the inhabitants of an economy. This
is because if real GDP per head rises so the population can enjoy more goods and services.
Additionally economic growth can reduce poverty: higher output raises tax revenue which
can be used in schemes to help the poor; as the maximum output of an economy increases
more workers may be needed so economic growth can help reduce unemployment and get
nearer to full employment. Also, it is important that the growth is sustainable as otherwise
future generations wont be able to expand productive capacity in the future so the economy
will stop growing.
3) Low and stable inflation is important because consumers and businesses have more confidence in
the purchasing power of their money so they can make long term plans more easily. It is important
that this is stable because then, as business have more confidence, they dont react as quickly to short-
term instability (raising prices and wages) which keeps inflation low. It is important inflation is low as
opposed to high as high inflation means businesses are concerned about protecting themselves and
spend money and time on this; they push up prices and wages. This process can become cyclical
leading to higher and higher inflation rates which is tough for those who have incomes that dont keep
pace with inflation (such as pensioners). Its also important because it enables firms to reduce costs by
not raising wages in line with inflation as opposed to making some workers redundant. Also, despite
workers real wages falling, this is physiologically better than firms reducing money wages which
would occur without inflation and leads to resistance from workers. Also, low inflation helps prevent
fiscal drag (which occurs when there is high inflation) which causes annoyance as taxpayers can
experience a fall in their disposable income.
4) A sustainable balance of payments position is important because it ensures the aggregate
demand and economic output of an economy remains high. If the position is not sustainable
this can have a negative impact on the economy. If a country has a current account deficit
more money is leaving a country than entering it so a country is consuming more than it is
producing. The income of this is going to people abroad so, when deficits increase too much,
aggregate demand in the economy decreases. This in turn lowers the economys output and
raises unemployment. Too great a current account surplus is also arguably undesirable as
opportunity cost of greater exports is greater consumption at home; when one country is in
surplus another must be in deficit (even if that country is not being directly traded with) and,
as expressed previously, if this is too great there is a negative effect in that country and, as
aggregate demand decrease there, it will set off a chain reaction starting with all the countries
it trades with etc.
c) a. Unemployment:







The orange line here shows the number of people unemployed from 1992 to July 2013. The general
trend the graph shows here is that unemployment was at its highest in 1992 (above 3 million) before
falling gradually till 2000 and remaining relatively constant till 2008. After this, there is a sharp rise in
unemployment till 2009 (where it reaches similar levels to that in 1992) and since then (till now)
unemployment has remained relatively constant at 2.5 million. A notable jump is that from 2008-
2009 but this is not an anomaly as unemployment remains at this level after that.





b. Economic Growth
This graph shows the economic growth in the UK in the last ten years through the percentage
change in GDP. There is quite a wide variation in economic growth across the period ranging from
1.5 percent GDP growth to -2.5% GDP growth. The general trend is that from 2003 2008 there was
low, sustainable economic growth, ranging between 0.1 and 1.5% growth across the period.
However, from 2008 2010 there was constant economic decline, reaching -2.5% in early 2009,
before returning to growth after a sharp rise in mid 2009. The period 2010 now however is
characterised by uncertainty, with economic GDP percentage change constantly fluctuating between
positive and negative values (the highest being 1 percent in mid 2010 and lowest -0.5 percent in
early 2012.
c. Inflation








This graph shows the changing inflation rate in the UK in the last ten years. There is quite a wide
variation in inflation rate across the period ranging from 5 percent to 1 percent. The general trend is
that from 2003 mid 2007 there has been low and quite stable inflation with the rate gradually
rising from 1 percent. However, the period after that is characterised by constantly fluctuating
inflation rates with a sharp rise to 5 percent in late 2008 before a sudden fall to 1 percent within a
year before returning to 5 percent in late 2011 and falling back down to the current level of 2-3
percent.
d. Income Distribution

This graph illustrates





















e. Balance of Payments Position












This Graph illustrates the UKs balance of payments position from 2000-2012 through showing the
current account deficit as a percentage of GDP. The UK current account shows that the UK has had a
persistent current account deficit for the past decade. Throughout the period the current account
deficit has fluctuated a lot but since 2008 the fluctuations have been both more frequent and
greater i.e. the biggest jump is from -1.5 percent (2011 Q3) to -4.5 percent (2012 Q1).
ii) Overall the UK isnt meeting the targets listed above. In terms of low unemployment, UK
is currently at 7.8 percent (2.51 million (latest ONS statistics)) which is above the 7% target
set by the Bank of England and way off the ideal scenario of full employment (3 percent.)
The target of stable and sustainable economic growth is not being reached as since 2008 there
has been frequent fluctuation between the economy growing and diminishing. This shows
economic growth is not stable at all; it is not sustainable as it has not continued over time
for even a short amount (it has only undergone around a 1 year consecutive period where
there has been continuous economic growth). The target of low and stable inflation isnt
being met because the inflation rate has fluctuated a lot since only 2010 ranging between 0
and 5 percent in this period. However, in the very short term (since Q2 2012) there has been
low and stable inflation, resting between the ideal target set by the bank of England at 2-3
percent. In terms of the balance of payments position, there is a current account deficit but
that is perhaps unavoidable, but UK targets are not being met as the deficit is extremely high
at the moment (sinking to -4.5 percent in 2012 Q1) which highlights how the UK is not
keeping to its intended target. The more frequent and extreme fluctuations since 2008
indicate that the UKs balance of payments is not stable therefore not sustainable.








The worrying part, is the deterioration in the current account towards the end of 2012. A
current account deficit of 3% of GDP is worrying because :




This deficit is despite a 25% depreciation in the value of sterling. In theory, a
depreciation should make UK exports more competitive and help to rebalance the
economy.
The deficit is despite a deep recession, which usually leads to an improvement in the
current account due to lower import spending.
(In evaluation, it could be pointed out that Europe, our main trading partner, is
experiencing a deeper recession hence there is one reason for relatively poor export
growth)