A2 Economics Macroeconomics Revision Workbook - April 2010

A2 Economics
Macroeconomics
Revision Workshop
Student Name
Session 1
Globalization: Shifts in Global
Trade and Investment
2009 was a difficult year for the global economy
Economic growth in a selection of countries 2008 2009 2010

World output 3.0 -0.8 3.9
United States 0.4 -2.5 2.7
Euro area (16 countries) 0.6 -3.9 1
Germany 1.2 -4.8 1.5
Japan -1.2 -5.3 1.7
United Kingdom 0.5 -4.8 1.3
Africa 5.2 1.9 4.3
Russia 5.6 -9.0 3.6
Developing Asia 7.9 6.5 8.4
China 9.6 8.7 10
India 7.3 5.6 7.7
Brazil 5.1 -0.4 4.7
Source: International Monetary Fund, Economic Outlook, February 2010, 2010 data are IMF forecasts
Making connections –
five ways in which the world recession has affected the UK economy
2 A2 ECONOMICS Revision Workshop April 2010

Foreign direct investment in the world economy
1 What are the main determinants of foreign investment decisions?
Examples of each to use
Access to natural resources
Closeness to growing consumer markets
Access to technology and intellectual property
Efficiency gains from out-sourcing production to lower cost countries
Other factors
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Using AD/AS to illustrate some of the gains from inward investment
Price Level
AD2
LRAS
SRAS
National Output Y2
Possible costs of Foreign Direct Investment
Worker exploitation issues
Doubts over job creation
Environmental aspects
Remittance of profits overseas
Impact on domestic firms
Other disadvantages

2 Changing Patterns of FDI Flows
Developed countries (MEDCs) still provide the bulk of foreign direct investment flows
1 Between developed countries
2 From developed to developing / emerging countries
But there is a clear shift in the pattern of FDI. More FDI from emerging economies to lowest
income countries (LICs). And also rising FDI from emerging economies to developed nations
• Much of this shift is the result of trade imbalances – e.g. the strong trade surpluses of
countries such as China, India, Brazil and Russia + the other main oil-exporting nations
3 The rise of FDI from emerging market countries

Here are some examples of large scale investments made in African countries from the BRICs
2009 Liberia China Mining $2.6 billion FDI

2009 Chad India Textile $25 million Line of credit
2009 S.Tome/Principle India Priority projects in agriculture, $5 million Line of credit
capacity building, infrastructure
2009 S.Tome/Principle India Small and medium enterprises sector $1 million Grant
2009 Mozambique India Rural electricity projects $30 million Line of credit
2009 Nigeria Russia Gas $2.5 billion Investment
2009 Angola Russia Construction $500 million Investment
2009 Angola Russia Telecommunications $328 million Investment
2009 Angola China Oil $1.3 billion Acquisition
2009/13 Nigeria Brazil Oil $2 billion FDI
2009/13 Angola Brazil Oil $800 million FDI
2010 Zimbabwe China Development projects $2.9 million Grant
2010 Zambia China Development projects, Commerce, $1 billion Concessional
Trade and industry loan
2010 Zambia China Stadium in Ndola $10 million Grant
2010 Malawi India Development projects $50 million Line of credit
2010 Malawi India Earthquake relief and projects $5 million Grants
2010 Zambia India Construction of the Itezhi-Tezhi $50 million Line of credit
Hydropower project
2010 Zambia India Social sector $75 million Soft loan
2010 Zambia India Health and education $5 million Grant
2010 Tanzania China Infrastructure & ICT sector $180 million Concessionary
loans
2010 Mozambique Brazil Mining $1.3 billion Investment
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Evaluating benefits & costs of FDI for lowest income countries
Economic advantages
Exports
Capital
Health
Finance
Environment
Costs and risks of FDI for the lowest income countries
Trade
deficit
Capital
flight
Labour
migrants
Rogue
donors?
Other
costs
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De-globalisation – the return of protectionism
Background notes:
The global financial and economic crisis led to a recession in the world
economy in 2009. When individual countries are in economic trouble the
lobbying for protectionist policies nearly always gathers momentum and
this has certainly happened in the last two years. Global Trade Alert’s latest
report identifies no fewer than 192 separate protectionist actions since
November 2008, with China as the most common target. Russia has
introduced the biggest number of protectionist measures since the crisis
started - and of course Russia is not a member of the WTO so it not bound
by any commitment to reduce trade barriers.

Import Tariffs
Example
Import Quotas
Example
Government Subsidies
Example
Controls on Mergers and Takeovers

Example
Immigration Restrictions
Example
Favouring Domestic Businesses

Example
Currency Manipulation
Example
Extra Bureaucracy
Example
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Analysis and evaluation of import tariffs
When analysing a tariff try to consider the direct and indirect effects on consumers and producers.
And also use economic welfare concepts such as consumer and producer surplus.
Price
Domestic
Supply
World supply
P1 pre-tariff
Domestic
Demand
Q1 Q2 Output
Consumers
Domestic
producers
Government
Importers
Indirect effects of tariff protection

There are many indirect (or second round) effects of decisions to introduce tariff or other forms
of import protection and strong evaluation in an exam answer might focus on some of the following
areas.

Retaliation
Economic by affected
Efficiency nations
Lower
Costs and income
Inflation groups
Analysis and evaluation of import quotas
Price
Export supply
of steel (no quota)
P1
Import demand
for steel
Q1 Output
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Anti-Dumping Duties and Developing Countries
88 of the 104 anti-dumping cases taken to the World Trade Organisation in the second half
of 2009 were brought by developing countries against subsidised imports.
What is dumping?
What are the aims behind dumping?
How might dumping affect a developing economy that alleges dumping by another country?

Currency manipulation
Some countries have been accused of resorting to competitive devaluations in a bid to increase
their competitiveness in international markets.
Advantages of currency devaluation Risks from deliberate currency devaluation
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Session 2 Poverty, Inequality
and Unemployment in the World Economy
The World Bank on poverty
“Poverty is hunger. Poverty is lack of shelter. Poverty is being sick and not being able to see a
doctor. Poverty is not having access to school and not knowing how to read. Poverty is not having
a job, is fear for the future, living one day at a time. Poverty is losing a child to illness brought about
by unclean water. Poverty is powerlessness, lack of representation and freedom.”
What is the difference between absolute poverty and relative poverty?
Evidence on extreme Less than $1.25 a day 1990 2005 2015

poverty in the world China 60.2 15.9 5.1
economy
India 51.3 41.6 23.6
Sub-Saharan Africa 57.6 50.9 38.0
Latin America 11.3 8.2 5.0
Total 41.7 25.2 15.0
Less than $2.00 a day 1990 2005 2015

China 84.6 36.3 16.0
India 82.6 75.6 58.3
Sub-Saharan Africa 76.2 73.0 59.6
Latin America 19.7 16.6 11.1
Total 63.2 47.0 33.7
What effect has globalization had on the level of poverty?
Poverty is not just about income – which other indicators might be used to measure extreme
poverty in the world’s lowest income countries?
1
2
3

Relative poverty
• Income or wealth compared to other members of society
• Gini-coefficient of inequality is the most commonly used measure of inequality
• The coefficient varies between 0, which reflects complete equality and 1, which
indicates complete inequality (one person has all the income or consumption, all
others have none).
Per Capita Income Statistics (PPP)

measured in US dollars 2007 2010 2014
Median $7,417 $7,902 $10,007

Mean $13,074 $13,597 $16,010
Top $85,371 $95,597 $88,779
Bottom* $313 $347 $438
% Top over bottom 27149% 27327% 20162%
Source: IMF World Economic Report October 2009; News N Economics
Per capita income data is measured in PPP terms – purchasing power

parity – and in US dollars. Identify two of the limitations of expressing data
in this way
1
Estimates of Gini coefficients in different countries
Denmark 24.7 Brazil 55.0

Japan 24.9 South Africa 57.8
Sweden 25.0 Bolivia 58.2
Norway 25.8 Colombia 58.5
Czech Republic 25.8 Angola 58.6
Slovakia 25.8 Haiti 59.5
Germany 28.3 Botswana 61.0
Ethiopia 29.8 Namibia 74.3
The Gini index lies between 0 and 100. A value of 0 represents absolute equality
and 100 absolute inequality. Source: World Bank 2009 Development Report.
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Determinants of relative poverty in developed and developing
countries
The causes of relative poverty are complex and will vary from country to country at different stages
of economic development. Many of these factors can be applied across nations.
Factors Revision Notes

Wage inequalities
Weaknesses in human capital
Taxation and welfare systems
Effects of high unemployment
Discrimination in the labour market
Debt constraints
Impact of food and energy price inflation
Impact of climate change
The spike in global food prices in 2007-08 was good news for some countries but created huge
problems for millions of poor consumers in economies across the world. The World Bank called
high food and energy price inflation the “silent tsunami” causing many millions of people to
experience severe poverty. And then in 2009 came the world recession. In this section we consider
some of the effects of the recession on developing countries.

Low Income Countries and the Global Recession
Lower income nations did not cause the global crisis but they have been affected in many ways
by the fall-out from the credit crunch and the subsequent recession.
Impact of the world recession on Revision Notes

Foreign direct investment flows
Commodity prices and horticulture exports
Tourism industries
Employment
Income from remittances
Aid receipts
Anti-Poverty Strategies in Developing Countries

Examples of policies Main aims Examples
Micro Finance programmes
Investment in sustainable energy
Social entrepreneurship
Investment in human capital
Empowering women in developing
countries
Inward investment to boost
infrastructure and productivity
Help in adapting to climate change
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Unemployment and poverty in developed countries
Unemployment is a huge policy issue for governments around the world. In this section we focus
on the problems facing developed nations. But taking a world view, the International Labour Office
estimates that the global unemployment rate for 2009 was estimated at 6.6 per cent. That means
that 212 million people were unemployed.
The main causes of unemployment
Cyclical unemployment
Structural unemployment
Frictional unemployment & other causes

Policies Recent examples in the UK
Macroeconomic stimulus policies
Employment subsidies
Attracting inward investment
Investment in human capital
Taxation and welfare reforms
Support to encourage entrepreneurship
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Session 3 Macroeconomic
policies during the global economic crisis
The world recession has prompted a remarkable attempt by many countries to use macroeconomic
policies to stabilize confidence, demand, output and jobs. Many nations have been hit badly by
external and domestic shocks and some have been taken into “intensive care”! The NICE decade –
a long period of non-inflationary continuous expansion – has come to an end and some economists
now believe that developed nations will suffer from a DRAG decade – deficit reduction anemic
growth!
At A2 level you will need to use some of the AD/AS analysis that was covered last year in the AS
economics course. But for higher marks you should show a good up to date understanding of what
has been happening. And be willing and able to evaluate the possible consequences of the various
policies chosen. We will look at stimulus policies in different countries and also consider some of the
difficulties facing countries inside the Euro Area.
Main Macroeconomic Policy Options

Monetary Policy
• Changes in policy interest rates
• Quantitative easing (QE)
• Attempts to change the external value of the currency
• Changes in the availability of credit (lending rules)
Fiscal Policy
• Automatic stabilisers
• Discretionary increases in government borrowing

Monetary Policy in the recession
Monetary Policy
• Policy interest rates
• The exchange rate (depending on the choice of exchange rate system)
• The availability of credit in the financial system
To influence
• The level and growth of aggregate demand and output
• Meet an inflation target and achieve price stability
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Why have central banks cut interest rates to ultra low levels
1 Response to the credit crunch
2 Risks of price deflation
3 To prevent an economic depression
4 To stabilize confidence and demand
Stabilizing the economy – interest rates and the importance

of the output gap

Does monetary policy work anymore?
How effective is monetary policy in achieving its aims? The ultra-low interest rates of the last
couple of years ought to have had a big effect on economic activity. But there are good reasons
for thinking that the impact of monetary policy has diminished. Some economists now talk about
a liquidity trap effect.
The Liquidity Trap
Cheap credit but limited loan availability
Damaging effect of low interest rates on savers
Lengthening time lags for interest rates to have an impact
Paul Krugman on the problems of being in a liquidity trap

“Being in a liquidity trap reverses many of the usual rules of economic policy. Virtue becomes vice:
attempts to save more actually make us poorer, in both the short and the long run. Prudence
becomes folly: a stern determination to balance budgets and avoid any risk of inflation is the road
to disaster. Mercantilism works: countries that subsidize exports and restrict imports actually do
gain at their trading partners’ expense.”
Interpreting this statement
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Quantitative Easing (QE)
The Bank of England introduced a policy of quantitative easing in March 2009. The Bank of
England has bought up to £200 billion of assets - mainly government bonds financed by the
issuance of new central bank reserves.
Bank of Buys bonds - This lowers the

England creates drives bond yield (interest
new money prices higher rate) on bonds
Commercial should Boosts demand

banks now have stimulate more in economy
more deposits lending
Revision notes on quantitative easing
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Fiscal policy – aggregate demand and supply effects
Our focus here is mainly on how fiscal policy has been used to manage the economy during the
financial crisis and recession. But it is important to understand that fiscal policy decisions affect
both aggregate demand and aggregate supply. Indeed many of the fiscal stimulus policies of the
last few years might also have significant effects on aggregate supply.
Fiscal stimulus policies in the UK during the recession
Taxes Subsidies
Budget Govt
deficit spending

Economics of the budget deficit
Fiscal policy has been used to actively manage demand in the UK and in other countries during
the recession. A rising budget deficit is an expansionary fiscal policy. But what are the likely
consequences of huge state borrowing?
Fiscal deficits – the economic benefits and risks

Justifying higher government borrowing Economic risks of a high budget deficit
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Evaluation: The Importance of the Fiscal Multiplier
The fiscal multiplier measures the final change in national income that results from a deliberate
change in either government spending and/or taxation. Several factors affect the likely size of
the fiscal multiplier effect.
Factor Comment
1 Choice of stimulus: Tax cuts or higher
government spending?
2 Taxes: Who are the beneficiaries of tax

reductions?
3 Expectations of taxation in the future
4 Availability of credit for businesses

affected by fiscal stimulus policies
5 Openness of the economy – and the

level of the exchange rate
6 Monetary policy response to a large

rise in government borrowing
7 Amount of spare capacity in the

economy (size of the output gap)
8 General level of consumer & business

confidence / uncertainty

Analysis: Recession and the impact of automatic stabilisers
When an economy suffers one or more domestic or external shocks, there are some natural
automatic stabilisers at work that ought to help moderate or dampen the effects on demand,
GDP profits and jobs without any explicit decisions from a government. The world recession
of 2009 has brought these stabilisers into focus.
Automatic Stabilisers
1 Welfare payments
2 Floating exchange rate
3 Public sector jobs
4 Reduced tax take
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Build the case for a higher inflation target
The risks of allowing inflation to be higher
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Session 4 UK Economy in Focus –
Issues facing the UK economy in 2010 and beyond
In this special macroeconomics presentation we will consider key recent
developments in the UK economy and try to connect as many different parts
of the AS macro course together as we can. How strong is the economic
recovery likely to be? What are the main risks for the UK economy in the
months and years ahead? Are there good reasons to be cheerful?
During this presentation jot down arguments and ideas that you find most relevant – and use
this as a great chance to show the examiner that you are right up to date with important
developments in the UK and world economy! This will boost your evaluation marks!
Issues Facing the UK Economy

Session 4 Study Notes
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The end of the NICE decade
Dangers of a permanent loss of output and a slower underlying rate of growth

National A deep recession may cause damage to an
Output economy’s potential growth rate
Some of the lost output may be unrecoverable

and the trend growth rate in a recovery might
be slower than in the past
Trend
Time
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Session 5 Aiming for the A* -
improving your evaluation and analysis skills
In this session we will look at two questions – one requiring analysis and one requiring evaluation.
We will then look at approaches to the question that provide hints on how to score high marks
on analysis and critical evaluation in your A2 papers. After this we concentrate on evaluation skills
that can be applied to every question. And we will flag up some handy evaluation phrases that can
signpost your attempts at evaluation in the exam.
Practice Questions
The chart above shows the annual rate of consumer price inflation for four countries over the
period from 2005 through to 2010. In the exam you will be given some stimulus material in the
form of charts, tables and written extracts. It is essential that you make effective use of this
material in your answers. We will do this in our discussion of these two questions:
1 Analysis: Explain why inflation rates may differ between countries
2 Evaluation: Evaluate the view that low inflation should no longer be the number
one priority for macroeconomic policy
Take ten minutes or so to jot down some thoughts to these questions in the space provided on
the next page. We will then take you through some suggestions for these questions.

Jot down your answers here
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New A2 Unit 4 Macroeconomic Exam Questions (AQA)
Note: 10 mark questions appear in the data response question, 15 mark

questions appear in the main essay paper. 25 mark questions appear in both the
data and essay sections.
Analysis questions
1 Explain the concept of economic growth and analyse two ways in which
international trade can increase a country’s economic growth (10 marks)
2 Explain the term ‘recession’ and analyse two possible causes of a recession
(10 marks)
3 Explain the concept of the natural rate of unemployment and the factors
which might determine it (15 marks)
4 Explain how fiscal policy might be used to bring about supply-side

improvements to an economy (15 marks)
5 Explain the factors which help determine the exchange rate of a currency
(15 marks)
Evaluation questions
1 Using the data and your economic knowledge, assess the possible impact
on the UK economy of greater openness to world markets (25 marks)
2 Using the data and your economic knowledge, assess the possible effects
on UK macroeconomic performance of an external economic stimulus,
whether arising from other EU members or from other parts of the world
(25 marks)
3 Evaluate the consequences for UK unemployment of a movement away from

spending and importing towards saving and exporting (25 marks)
4 The level of UK public sector spending grew from 37% of GDP in 1997 to
over 45% in 2008. To what extent do you regard such an expansion of the
public sector as beneficial to the UK economy? (25 marks)
5 In a floating exchange rate system, a currency may be subject to frequent

fluctuations in its external value. Discuss the possible economic
consequences of such fluctuations for the achievement of a country’s
macroeconomic objectives. (25 marks)
Revision resources from Tutor2u

Ahead of the exams this summer our economics blog will be carrying daily revision updates,
news and comment on economic events and useful articles on exam technique. Have a look
at our free blogs and other resources by going to
www.tutor2u.net/blog/index.php/economics

UK Economy at a Glance Recession Recovery
2009 2010 Comment
Consumer spending -3.1 0.4 Modest rebound in spending - tax rises, high
unemployment and continued need to repay debt
Government consumption 2.0 1.7 Squeeze on real government spending likely to be
delayed until 2011 when the Politics is settled
Investment -14.4 -0.5 Deep cut in capital spending last year - less severe in
2010 but weak demand holds back investment
Stockbuilding (% GDP) -1.2 1.0 Many firms cut back on stocks/ production in 2009,
signs of a recovery in inventories in 2010
Domestic demand -5.1 1.6 Overall C+I+G was strongly negative in 2009 (a largely
home-made recession?) Weak again in 2010
Exports -10.9 4.8 Exports hit by sharp fall in global output/trade in 2009.
More positive in 2010 - weak sterling helping?
Imports -12.1 3.0 Imports slumped as UK went into downturn (UK has
high income elasticity of demand for imports)
GDP -4.9 2.0 Deep recession (-6.2% over course of recession) -
scraping towards 2% growth in 2010 (the new trend?)
Manufacturing output -10.4 3.2 Collapse in industrial output in 2009 but more positive
signs as industry benefits from weak pound
Unemployment LFS measure (%) 7.6 7.7 Unemployment to stay lower than in the last recession -
fewer hours and wage cuts have helped
Unemployment CC measure (%) 4.9 6.1 Claimant count also likely to peak below 2 million -
but long term unemployment is a worry
Labour force (million) 31.4 31.2 Small shrinkage in size of labour force - partly reverse
migration and discouraged worker effect
Average earnings (inc. Bonuses) -0.1 3.4 Negative earnings growth for millions in 2009 - pay cuts
and pay freezes (but CEO pay remained strong)
RPI Inflation -0.5 3.8 Some deflation in 2009 (mainly due to big cuts in
mortgage interest rates) - RPI spikes higher in 2010
CPI Inflation 2.2 2.8 CPI has remained above target during the recession -
policy makers happy to ignore this for now
Real wages (deflated by CPI) -1.0 -2.6 Important data - in this recession, real wages have fallen
for a significant number (wage flexibility?)
Productivity (output per worker) -3.2 3.0 Drop in productivity in 2009 explained by weak output -
but also long term factors limiting efficiency
Unit labour costs (ULCs) 4.3 -3.4 2010 will see a fall in UK unit labour costs - an
improvement in competitiveness which will help
BoP Current Account (% GDP) -1.1 -0.7 UK heading back to balance / equilibrium on the
balance of payments, not really a policy issue
Budget Balance (% GDP) -11.0 -10.1 This is the big macro policy issue - how much borrowing
can be sustained? When to squeeze policy?
Government debt (% of GDP) 68.6 80.3 Sharp rise in government debt (although lower than
many EU countries) and much debt is long-dated
US Dollar /Sterling $1.57 $1.61 Relative exchange rate stability against the dollar?
Hard to forecast - many UK imports priced in Ss
Sterling / Euro Euro 1.11 Euro 1.09 Euro set to gradually strengthen against sterling despite
woes of the PIGS
Base (policy) interest rate (%) 0.5 0.5 Policy interest rates set to remain below 1% for at least
the rest of the year - MPC in wait and see mode
10-year government bond yield (%) 4.1 3.4 Where next for bond yields? Much depends on
election result and credibility of new govt fiscal plans
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A2 MACRO Key Term Glossary
AAA credit rating The best credit rating that can be given to a corporation's bonds, effectively
indicating that the risk of default is negligible.
Accelerator effect Where planned capital investment is linked positively to the past and expected
growth of consumer demand.
Accommodatory policy A neutral macroeconomic policy stance in the face of an economic shock. For fiscal
policy, generally means keeping tax and government expenditure rates unchanged.
For monetary policy, generally means keeping (real) interest rates unchanged.
Aggregate supply shock Either an inflation shock or a shock to potential national output; adverse
aggregate supply shocks of both types reduce output and increase inflation.
Animal spirits The state of confidence or pessimism held by consumers and businesses.
Automatic stabilisers Automatic fiscal changes arising automatically as the economy moves through
different stages of the business cycle - for example a fall tax that the government
takes out of the circular flow in a recession.
Bank run When a substantial number of depositors suspect that a bank may go bankrupt
and withdraw their deposits. Bank runs are rare but one happened with the
Northern Rock in the autumn of 2007.
Beggar my Neighbour This is an economic policy that seeks to promote a country's economy at the
expense of another country. An obvious example is the use of tariff barriers. A
country may place tariff on imports to help promote local domestic industry. This
may help local unemployment, but, be at the expense of the other country's export
sector.
Behavioural economics Branch of economic research that adds elements of psychology to traditional models
in an attempt to better understand decision-making by investors, consumers and
other economic participants.
Bond Both companies and governments can issue bonds when they need to borrow
money. The issue of new government debt is done by the central bank and involves
selling debt to capital markets.
Brain drain The movement of highly skilled or professional people from their own country to
another country where they can earn more money.
BRIC economies The BRIC grouping – Brazil, Russia, India and China – has become short hand for
the rise of emerging markets in the global economy. The BRICs already have a
bigger share of world trade than the USA.
Bubble When the prices of securities or other assets rise so sharply and at such a sustained
rate that they exceed valuations justified by fundamentals, making a sudden
collapse likely (at which point the bubble "bursts").
Budget deficit Occurs when government spending is greater than tax revenues. The UK budget
deficit in 2009-10 is forecast to be more than 12% of GDP.
Business confidence Expectations about the future of the economy – vital in business decisions about
how much to spend on new capital goods.
Capacity The amount that can be produced by a plant, company, or economy (industrial
capacity) over a certain period, if current resources (including capital, workers,
etc.) are used to their fullest extent.
Capacity utilisation Measures how much of the productive potential of the economy is being used.
Utilisation falls during a recession.
Capital flight The rapid movement of large sums of money out of a country. There could be
several possible reasons - lack of confidence in a country's economy and/or its
currency and political turmoil.
Capital flows Movements of capital between countries. Outward capital flows are movements of
domestically-owned capital abroad; inward capital flows are movement of foreign
owned capital to the domestic economy.
Capital stock The value of the total stock of capital inputs in the economy – affected by the rate
of net investment spending.
Capital-labour substitution Replacing workers with machines in a bid to increase productivity and reduce unit
costs. This can lead to structural unemployment.
Carry trade A strategy in which an investor borrows money at a low interest rate in order to
invest in an asset that is likely to provide a higher return.
Car scrappage scheme This is a scheme co-funded with the car industry that had the objective of increasing
the demand for cars in the UK.

Catch-up effect This occurs when countries that start off poor tend to grow more rapidly than
countries that start off rich. The result is some convergence in the standard of
living as measured by per capita GDP.
Claimant Count The number of people claiming unemployment-related benefits. Since October
1996 this has been defined as the number of people claiming Jobseeker's Allowance.
Classical LRAS The classical LRAS curve is drawn as vertical because classical economists argue
that a country’s productive capacity is determined by factors other than price and
demand such as investment and innovation.
Classical unemployment Classical unemployment is the result of real wages being above their market
clearing level leading to an excess supply of labour.
Clean float A currency exchange rate that varies (or floats) according to market forces, free
from government intervention.
Comparative advantage Comparative advantage refers to the relative advantage that one country or
producer has over another. Countries can benefit from specializing in and exporting
the product(s) for which it has the lowest opportunity cost of supply.
Competitive devaluation When a country tries to devalue its currency to increase its international
competitiveness. However, this often encourages other countries to also devalue
leading to only temporary increases in the competitiveness of exports.
Consumer confidence Expectations about the future including interest rates, incomes and jobs
Counter-cyclical Not following the normal pattern of business activity, for example increasing when
other activities are decreasing.
Countervailing tariffs Tariffs (duties) that are imposed by a country to counteract subsidies provided to
a foreign producer.
Credit crunch When creditors become reluctant to lend money to businesses or individuals
because of the increased risk of default due to adverse economic or political
conditions.
Creeping inflation Small rises in the general level of prices over a long period of inflation.
Creeping protectionism A period of time where import tariff rates rise and where countries introduce
quotas and barriers to the mobility of labour and capital.
Currency union A group of countries (or regions) using a common currency – for example the 16
countries that have entered the single European currency.
Current account deficit The amount by which money relating to trade, investment etc going out of a country
is more than the amount coming in.
Cyclically adjusted Adjusting the value of an economic variable e.g. the budget deficit for the effects
of the business cycle.
Debt burden The amount of debt that a business or country has normally expressed as a share
of GDP.
Debt deflation High levels of debt leading to falling asset prices.
Debt forgiveness The cancelling by a creditor of a debt to a country or a company.
De-industrialization A decline in the share of national income from manufacturing industries.
Deflation A persistent fall in the general price level of goods and services.
Depression Used to describe a severe recession which may become a prolonged downturn
in the economy and where GDP falls by at least 10 per cent.
Discouraged workers People often out of work for a long time who give up on job search.
Discretionary fiscal Deliberate attempts to affect aggregate demand using changes in government
policy spending, direct and indirect taxation and borrowing.
Discretionary income Disposable income adjusted for spending on essential bills such as fuel.
Disequilibrium Disequilibrium unemployment comes about when the aggregate demand for
unemployment labour is less than the aggregate supply of labour at the current real wage rate
and market forces are failing to correct the problem.
Double dip recession When an economy goes into recession twice without having undergone a full
recovery in between.
Dumping When a producer in one country exports a product to another country at a price
which is either below the price it charges in its home market or is below its costs
of production.
Economic nationalism The idea that a country's economy will perform best if its industries are protected
from competition, for example by taxes on imported goods.
Economic shocks Unpredictable events such as volatile prices for oil, gas and foodstuffs.
Economic stability When the main indicators such as growth, prices and unemployment do not
change much from one year to another.
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Emerging markets The financial markets of developing countries.
Expansionary monetary A policy by monetary authorities to expand money supply and boost economic
policy activity, mainly by keeping interest rates low to encourage borrowing by
companies, individuals and banks.
Expectations How we expect the future to unfold – this can have powerful effects on the
spending decisions of households, businesses and the government.
Fine-tuning Changes in monetary policy or fiscal policy designed to gradually manage the level
of aggregate demand and prices.
Fiscal drag The tendency of income from taxation to rise when an economy is growing. This
helps to slow consumer spending and corporate activity, and thus acts as a
counterbalance to unrestrained growth.
Fiscal stimulus Government measures, normally involving increased public spending and lower
taxation, aimed at giving a positive jolt to economic activity.
Fixed exchange rate An exchange rate that is fixed against other major currencies through action by
governments or central banks, usually within small margins of fluctuation around
the central rate. Likely to involve periodic intervention in the foreign exchange
market by one or more central banks to buy or sell the currency in question if it
moves below or above its margins.
Foreign direct investment FDI is the acquisition of a controlling interest in productive operations abroad by
companies resident in the home economy. May involve the creation of new
productive capacity such as a new factory.
Foreign exchange The reserves of gold or foreign currencies (e.g. US dollars or Euros) typically held
reserves by central banks on behalf of their national government.
Free trade When trade between nations is allowed to occur without any form of import restriction.
Full capacity output A level of national output where all available factor inputs are fully employed – this
is a factor influencing the underlying growth rate.
Full employment When there enough job vacancies for all the unemployed to take work.
Gini Coefficient The Gini coefficient is a measure of the overall extent to which groups of
households, from the bottom of the income distribution upwards, receive less than
an equal share of income.
Gilts Government bonds paying a fixed amount of money (‘coupon’) as interest annually
and redeemable at face value on maturity.
Globalisation The deepening of relationships between countries of the world reflected in an
increasing level of overseas trade and investment.
Golden Rule A rule introduced by the Labour government which says that borrowing on state
provided goods and services should be zero over the course of one economic
cycle. Borrowing is used to finance capital investment.
Hard landing A full-scale recession shown by a decline in real national output.
Hidden unemployment Unemployment which is known to exist but is not included in the official
government figures.
Hot Money Money that flows freely and quickly around the world economy looking to earn
the best available rate of return. It might be invested in any asset whose value is
expected to rise (e.g. property or shares) or simply be placed in an account
offering the best real rate of interest.
Infant industry New industry that requires government protection from overseas competition (for
instance through the setting of import tariffs) in order to develop.
Inflation target The Government sets the Bank of England a CPI inflation target, which is currently
2 per cent.
Infrastructure The transport links, communications networks, sewage systems, energy plants and
other facilities essential for the efficient functioning of a country and its economy.
Innovation Changes to products or production processes – innovation is important in
delivering improvements in dynamic efficiency.
Interest elasticity The responsiveness of demand to a change in interest rates. This is relevant in
of demand discussing the effects of changes in monetary policy.
International The IMF is an organisation of 186 countries, promoting global monetary
Monetary Fund (IMF) cooperation, financial stability, international trade, employment and sustainable
economic growth. It has provided help for several nations in the wake of the
2007-09 financial crises.
Investment income Interest, profits and dividends from assets owned and located overseas.

J Curve Effect The effect of currency depreciation on the trade deficit depends on price elasticity
of demand for exports and imports. In the short term, demand is often inelastic and
the J Curve effect says a trade deficit can actually worsen after depreciation, but
get better in the medium term.
Job search The process by which workers find appropriate jobs given their tastes and skills.
Keynesian economics The economics of John Maynard Keynes. The belief that the state can directly
stimulate demand in a stagnating economy. For instance, by borrowing money to
spend on public works projects like roads, schools and hospitals.
Labour shedding Cut backs in employment often seen in a slowdown or a recession.
Labour shortages When businesses find it difficult to recruit the workers they need.
Labour supply The number of people able, available and willing to work at prevailing wage rates.
Lagging indicators Indicators which tend to follow economic cycles e.g. unemployment.
Leading indicators Indicators which predict future economic trends e.g. consumer confidence.
Leveraging The use of borrowed funds to increase your capacity to spend or invest.
LIBOR London Interbank Offered Rate and - used by banks world-wide to determine the
rate at which they lend to each other - whether receiving or giving loans. Libor
rates are set daily and released at the same time everyday - 11am London time.
Life-cycle model A theory that says that savings rates depend on how old someone is.
Liquidity Liquidity refers to the ease with which something can be converted to cash with
little or no loss of value.
Macroeconomic The overall performance of an economy in terms of output, prices, jobs, global
performance trade and living standards.
Macro stabilization A coordinated set or group of mostly restrictive fiscal and monetary policies aimed
policies at reducing inflation, cutting budget deficits, and improving the balance of payments.
Managed floating An exchange rate that is basically floating but subject to intervention from time
currency to time by the monetary authorities, in order to resist fluctuations that they
consider to be undesirable.
Marginal propensity The proportion of any change in income that is spent rather than saved.
to consume
Marginal propensity The change in total saving as a result of a change in income.
to save
Marginal rate of tax The rate of tax on the next unit (£) of income earned.
Mercantilism The notion that the wealth of a nation was based on how much it could export in
excess of its imports, and thereby accumulate precious metals. Applied in the
modern context to countries accumulating huge trade surpluses in goods or
services and focusing on export-led growth.
Monetarism School of economic thought that considers money supply as the main factor
influencing the economy, and monetary policy as the key instrument of government
decision-making. Controlling money supply should ensure steady economic growth
and a healthy price environment. Opposed by the Keynesian school, which
considers fiscal policy as the key macroeconomic tool.
Money illusion Money illusion occurs when people confuse nominal and real values when making
economic decisions. Money illusion is most likely to occur when inflation is
unanticipated, so that people’s expectations of inflation turn out to be some
distance from the correct level.
Money supply The entire quantity of a country's commercial bills, coins, loans, credit, and other
liquid instruments in the economy.
Moral hazard When an insured party decides to take higher risks because they perceive their
losses will be covered – often linked to the excessive risk-taking by banks knowing
that central banks might rescue them.
Multiplier effect If there is an initial injection (e.g. a rise in exports) into the economy then the final
increase in AD and Real GDP will be greater.
NAFTA North American Free Trade Agreement - a free trade area agreement signed by the
US, Canada and Mexico.
NAIRU Non-accelerating inflation rate of unemployment: the number of people without
work that some economists say is necessary at a particular time in order to
prevent prices rising too fast.
National debt The total amount of debt that the government owes the private sector.
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Negative equity Negative equity occurs when the value of an asset falls below the outstanding
debt left to pay on that asset. Term is most commonly used in connection with
property prices and describes a situation where the market value of a house is
less than the existing mortgage debt.
Negative interest rate An interest rate that is below zero. For real interest rates, this can occur when the
inflation rate is higher than nominal interest rates.
Net investment Gross investment minus an estimate for capital depreciation.
Net inward migration When the number of migrants coming into a country is greater than those leaving
in a given time period.
Neutral interest rate A neutral interest rate is a rate of interest that neither deliberately seeks to
stimulate aggregate demand and growth, nor deliberately seeks to weaken growth
from its current level. In other words, a neutral rate of interest would be that which
is set at a level which encourages a rate of growth of demand close to the
estimated trend rate of growth of real GDP.
Non-inflationary growth Sustained growth of real national output whilst maintaining price stability
Open market operations Central bank intervention in money markets where it buys and sells securities to
control the money supply and the level of interest rates.
Output gap The difference between actual and potential national output. A negative output
gap after a recession implies that an economy has a large margin of spare
productive capacity.
Overseas assets Assets such as businesses, shares, property which are owned in overseas
countries and which might generate a flow of investment income which is a credit
item on the current account of the balance of payments.
Paradox of thrift The basic concept is that if people save more in a recession, it will reduce
consumption and thus aggregate demand will fall, impeding economic growth
and, in fact, lowering the general level of savings.
Phillips Curve A statistical relationship between unemployment and inflation.
Policy asymmetry When a given change in interest rates affects different groups or different
countries to a lesser or greater degree.
Potential output The economy's maximum productive capacity in a physical sense. The largest
output that could be produced, given the prevailing state of technology, with all
available labour, capital and land fully utilised.
Precautionary saving Saving because of fears of a loss of real income or employment.
Price stability Price stability occurs when there is low inflation and the price changes that do
occur have little impact on day-to-day decisions of people.
Productivity A measure of efficiency e.g. measured by output per person employed or output
per person-hour.
Protectionism The use of tariff and non-tariff restrictions on imports to protect domestic
producers from foreign competition.
Purchasing power parity Method of currency valuation based on the premise that two identical goods in
different countries should eventually cost the same. This is illustrated by the Big
Mac index.
Rational expectations Where decisions are based on current information and anticipated future events.
Reserve currency A foreign currency that is held in countries' official reserves because of its global
importance as a medium of exchange and its inherent stability.
Ricardian equivalence The argument attributed to David Ricardo that government budget deficits have
no lasting effects on economic activity. Rational taxpayers are supposed to
anticipate that tax cuts today will mean tax increases in future, and so save more
when the government saves less.
Quantitative easing Central banks flood the economy with money by printing new notes, to increase
the supply of money. The idea is to add more money into the system to avert
deflation and encourage banks/people to borrow and spend.
Quota A quota imposes a physical limit on the quantity of a good that can be imported
into a country in a given period of time.
Real disposable income Income after taxes and benefits, adjusted for the effects of inflation.
Real interest rate The nominal rate of interest adjusted for inflation.
Real wage The nominal wage adjusted for the effects of inflation.
Relative deflation The term “relative deflation” is generally used to describe an economy with an
inflation rate, which has not necessarily descended into negative territory, but is
markedly lower than comparable economies.

Remittances Sending of money to people in another country for example migrant workers
sending some of their wages to their home country.
Retail Price Index (RPI) The RPI is broadly similar to the CPI but includes mortgage repayments and some
taxes, and excludes the top 4 per cent of earners. It is used to calculate increases
in wages, state benefits and pensions.
Risk averse Exhibiting a dislike of uncertainty, often seen in a recession.
Saving ratio The percentage of disposable income that is saved rather than spent.
Soft landing A slowdown in activity but which does not result in a recession.
Sovereign wealth A government or state run fund usually created by profits from natural resources
fund (SWF) such as oil, gas or minerals. Highly secretive, their assets grew dramatically when
oil prices rose to record levels. Some of the largest SWFs are in the oil-rich
Middle East.
Spare capacity When a business is not making full use of its available capacity – there are spare
factors of production including land, labour and capital. When an economy has
plenty of spare capacity, short run aggregate supply tends to be elastic.
Special drawing rights A unit of money created by the IMF. Each member country can borrow SDRs at
favourable interest rates from the IMF's reserves when they are needed for
reasons related to a country's balance of payments.
Stability and growth pact EU's fiscal rule intended to maintain discipline in the public finances of Euro Area
member-states. The pact sets a limit for government budget deficits of 3 per cent
of gross domestic product in normal times.
Stagflation A combination of slow economic growth and rising inflation, can lead to stagflation.
The most notable recent period of stagflation occurred during the 1970s, when
world oil prices rose dramatically, and UK inflation rose at one point to nearly 30
per cent.
Sterling exchange The external value of sterling calculated using a weighted index of a basket of
rate index currencies – the weightings are based on the pattern of trade between the UK
and other countries.
Sustainable growth Growth which meets the needs of the present without compromising the ability of
future generations to meet their own needs.
Tariff A tax on imported products which may be ad valorem (%) or a specific tax (a set
amount per unit imported).
Tight labour market When demand for labour is high and there are shortages of labour. Businesses
may have to offer higher wages to attract more workers.
Time lags The time it takes for one change e.g. a change in interest rates to affect other
variables e.g. consumer confidence and spending.
Toxic debt Loans that may not be repaid.
Trade-off Choices have to be made between different objectives of policy.
Transmission mechanism How a change in interest rates affects sectors of the economy.
Trend growth The long run average growth rate – mainly determined by changes in the stock of
available factor inputs and also improvements in productivity.
Under-employment When people want to work full time but find that they can only get part-time work
– the result is a loss of hours that the economy can use.
Unemployment trap When the prospect of the loss of unemployment benefits dissuades those without.
work from taking a new job – creates a disincentives problem
Unorthodox monetary Any policy undertaken, usually by central banks, that operates outside the usual
policy parameters for influencing either the price or the quantity of money in an economy.
– this includes quantitative easing.
Unit wage costs Labour costs per unit of output.
Unsecured credit Credit not secured by another asset – i.e. money borrowed on credit cards.
Velocity of circulation The average number of times a unit of money changes hands in an economy
during a given period - normally measured by dividing the total amount spent
(GDP) by the amount of money available (money supply).
Wage price spiral A situation where workers bid for higher wages because they have seen their real
income eroded by rising prices. This can lead to a further burst of cost-push
inflation in an economy.
Wealth effect The supposed link between changes in wealth and household spending
World Bank Owned by 186 member countries, the World Bank is a source of financial and
technical assistance to developing countries. It normally targets public works and
other essential capital or social projects.
World Trade Organisation The WTO oversees trade agreements, negotiations and disputes between
member countries between member countries.
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Notes
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A2 Economics Macroeconomics Revision Workbook - April 2010

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A2 Economics

Economic growth in a selection of countries 2008 2009 2010

2 A2 ECONOMICS Revision Workshop April 2010

Examples of each to use

Access to natural resources

Closeness to growing consumer markets

Access to technology and intellectual property

Efficiency gains from out-sourcing production to lower cost countries

Possible costs of Foreign Direct Investment

Worker exploitation issues

Doubts over job creation

Remittance of profits overseas

Impact on domestic firms

4 A2 ECONOMICS Revision Workshop April 2010

3 The rise of FDI from emerging market countries

2009 Liberia China Mining $2.6 billion FDI

Costs and risks of FDI for the lowest income countries

8 A2 ECONOMICS Revision Workshop April 2010

Controls on Mergers and Takeovers

Favouring Domestic Businesses

Indirect effects of tariff protection

10 A2 ECONOMICS Revision Workshop April 2010

Analysis and evaluation of import quotas

What are the aims behind dumping?

12 A2 ECONOMICS Revision Workshop April 2010

Advantages of currency devaluation Risks from deliberate currency devaluation

What is the difference between absolute poverty and relative poverty?

Evidence on extreme Less than $1.25 a day 1990 2005 2015

Less than $2.00 a day 1990 2005 2015

What effect has globalization had on the level of poverty?

14 A2 ECONOMICS Revision Workshop April 2010

Per Capita Income Statistics (PPP)

Median $7,417 $7,902 $10,007

Per capita income data is measured in PPP terms – purchasing power

Estimates of Gini coefficients in different countries

Denmark 24.7 Brazil 55.0

Factors Revision Notes

16 A2 ECONOMICS Revision Workshop April 2010

Impact of the world recession on Revision Notes

Anti-Poverty Strategies in Developing Countries

The main causes of unemployment

Frictional unemployment & other causes

18 A2 ECONOMICS Revision Workshop April 2010

Main Macroeconomic Policy Options

20 A2 ECONOMICS Revision Workshop April 2010

1 Response to the credit crunch

2 Risks of price deflation

3 To prevent an economic depression

4 To stabilize confidence and demand

Stabilizing the economy – interest rates and the importance

22 A2 ECONOMICS Revision Workshop April 2010

The Liquidity Trap

Cheap credit but limited loan availability

Damaging effect of low interest rates on savers

Lengthening time lags for interest rates to have an impact

Paul Krugman on the problems of being in a liquidity trap

Interpreting this statement

Bank of Buys bonds - This lowers the

Commercial should Boosts demand

Revision notes on quantitative easing

Fiscal stimulus policies in the UK during the recession

26 A2 ECONOMICS Revision Workshop April 2010