REVIEW OF HWK

1. REVIEW OF HWK BoP Orange sheet Q&A

2. Balance of Payment Questions…. • What is meant by (2 marks each = 6 in total) • A trade gap? • A current account deficit? • A current account surplus? 2. Explain why an economic boom may result in a current account deficit. (3 marks) 3. Explain why a recession may result in an improvement in the current account position. (3 marks) 4. To what extent might a current account deficit have an effect on • Employment? • Inflation? • Growth? • 4 marks each = 12 marks Total = 24 marks

3. Balance of Payment Questions…. • What is meant by (2 marks each = 6 in total) • A trade gap? • the difference in value over a period of time of a country's imports and exports • A current account deficit? • Where M>X • A current account surplus? • Where X>M

4. Explain why an economic boom may result in a current account deficit. (3 marks) • Boom = lots of employment, consumer confidence, business profits…. • Confidence = C + I which can often lead to greater need for goods beyond domestic production, therefore greater iMports! • Draw a ‘boom’ macro diagram… what happens to prices? • So domestic goods more expensive & so less competitive, therefore less eXports! • Also exchange rates gets stronger – so SPICED! (later!)

5. Explain why a recession may result in an improvement in the current account position. (3 marks) • Draw a recession diagram • Increasing unemployment • Lower prices • Fall in confidence (both consumer and producer) • So more eXports with weaker exchange rates and lower prices – makes us more competitive • There ‘might’ be lower iMports – as they become more expensive…

6. To what extent might a current account deficit have an effect on employment? Inflation? Growth? • Where M > X • Fall in employment – but why? • Rise in inflation – but why? • Fall in growth – but why?

7. Inflation & Deflation Recap & move forward…

8. Recap • In theory – what are the 2 key causes of inflation? • Demand pull inflation • Cost push inflation

9. Recap • Can you draw me a demand pull inflation diagram (show SR & LR AS)

10. DEMAND PULL INFLATION SRAS2 LRAS Price Level SRAS In the LR, workers are not willing to sacrifice Leisure time for more overtime…. But still have high wage expectations…. demand pull inflation AD1 AD 0 Y2 Y1 Real National Output

11. Recap • Can you draw me a cost push inflation diagram (show SR & LR AS)

12. Draw an Classical AD/AS diagram LRAS SRAS2 Price Level SRAS1 AD 0 Y2 Y1 Real National Output

13. Recap • What was the more recent ‘FIVEr’ causes of UK’s rise in inflation last month?

14. Recap • What was the more recent ‘FIVE’ causes of UK’s rise in inflation last month? • F= Fuel • I = Imports create higher costs • V = VAT • Er= exchange rates

15. Deflation Is it good or bad?

16. Deflation • Deflation is a sustained fall in the general price level • A sustained period of negative inflation • The internal value of money rises, where consumers have a stronger purchasing power.

17. Where has there been deflation? The govt currently uses CPI as their headline statistic What is the current UK inflation rate?

18. Deflationary pressure for some products

19. What’s the start & end points? What’s the trend? Describe the changes in the data provided. What effects do you think this had on the economy?

20. The diagrams – demand side cause of deflation

21. ‘DEMAND PULL’ Deflation… LRAS Price Level SRAS AD AD1 0 Y2 Y1 Real National Output

22. Demand side causes of Deflation • A Large (adverse) Fall in AD • Exogenous shocks to the economy • A global recession leading to a fall in exports and investment • A rise in the exchange rate (leading to lower exports and cheaper imports) • Declines in domestic and international asset prices • Deliberate attempts by macroeconomic policy to reduce AD through tightening of fiscal and/or monetary policy

23. The diagrams – supply side cause of deflation

24. SR Cost ‘push’ deflation LRAS Price Level SRAS1 SRAS2 AD 0 Y2 Y1 Real National Output

25. LR Cost ‘push’ deflation LRAS LRAS Price Level SRAS1 Why is this type of deflation good? AD 0 Y1 Real National Output Y2

26. Supply side causes of deflation • An Increase in Long Run Aggregate Supply • The supply potential of the economy has been boosted by a series of beneficial shocks such as • Impact of rapid technological advances • Reductions in the international prices of commodities and capital goods • Higher productivity which drives down unit cost of production • Exploitation of economies of scale leading to lower LRAC • Excess supply in some industries due to over-investment in new capital machinery i.e. deflation results from a persistent demand deficit over existing and potential productive capacity.

27. Deflation – good and bad points!Make notes from the video clips Impact on Households? Consumers? Employees? Businesses?

28. Consequences of Deflation • Holding back on spending: • Consumers may opt to postpone demand if they expect prices to fall further in the future • Debts increase: The real value of debt rises when the general price level is falling and a higher real debt mountain can be a drag on confidence • Mortgage payers on fixed mortgage interest rates will see the real cost of servicing their debt increase • The real cost of borrowing increases: Real interest rates will rise if nominal rates of interest do not fall in line with prices • Lower profit margins: This can lead to higher unemployment as firms seek to reduce their costs. • Confidence and saving: Falling asset prices such as price deflation in the housing market hit personal sector wealth and confidence –leading to further declines in AD. Higher savings can lead to the paradox of thrift

29. Back to inflation… What are the ‘costs’ of inflation…

30. Shoe leather costs • With prices rising or falling, • Consumers & businesses ‘hunt’ out the best price deals… so more ‘walking’ around. • There is also a greater incentive to find the best place to ‘keep’ your money, moving funds to the highest return accounts….

31. Political costs • Food price protests in India, China, Russia, Bolivia, Egypt… • What can happen to the politics in a country when inflation grows. • Fighting inflation (7%) is a priority for China and the government must ward off threats to social stability stemming from rapid price increases and pressure to raise the value of the yuan, Premier Wen Jiabao said. "Rapid price rises have affected the public and even social stability. The Party and government have always made a priority of keeping prices at a generally stable level."

32. Menu costs • The need for companies • to keep updating their prices to reflect the change in their raw materials, in itself is a cost.

34. For India & China, where they spend a greater % of their income on food, inflation has had a significant impact

35. Psychological costs • The double-digit increases in other "must-pay" essentials such as food, petrol, gas and electricity. • Many families need to find more than £1,200 extra a year just to stand still. • Once higher mortgage costs are added, millions are having to pay out at least another £2,000 a year to keep their heads above water.

36. What does this mean?

37. Homework

38. How is inflation measured? • Do some research and write a description on how CPI is measured in the UK. • Make sure that in your explanation you use the following terms…. • Index • Average • Basket of goods • Consistent comparison • Weighting • Explain the difference between RPI & CPI