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Year 11 Semester 1 Revision Notes
Year 11 Semester 1 Revision Notes
- To reduce inequality in the country – to redistribute income and wealth in order to help the poor
Macroeconomics is the study of how a national economy works and the interaction between economic growth in output
and national income, employment and the general level of prices.
A macro-economy consists of all the different markets for goods and services, labour, finance, foreign exchange and other
traded items.
Changes in the behaviour of producers and consumers in individual markets will therefore have an effect on the macro-
economy and the rate of economic growth, inflation, employment and trade.
Governments can use different policy instruments, including taxes and regulations, to help achieve their objectives
through their impact on the actions of producers and consumers.
Fiscal policy involves varying total public sector expenditure and/or the overall level of taxation to influence the level of
demand in an economy.
Expansionary fiscal policy may be used during an economic recession to boost demand for goods and services through
tax cuts or increased public sector spending. Firms may respond by hiring more labour and increasing output. However,
increasing demand can force up market prices and involve spending more on imported goods and services from overseas.
Increasing imports will have a negative impact on the balance of payments.
Contractionary fiscal policy may be used to reduce price inflation. It involves reducing demand in an economy through
tax increases or cuts in public sector spending. However, firms may respond to falling demand by cutting their output and
reducing employment. Increased taxes may also reduce work incentives and therefore productivity.
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services as after-tax prices fall more labour
Raise public expenditure Public sector workers could be Firms supplying goods and services to government
paid more. Low income will enjoy increased revenues and profits, and may
families may receive more expand their output and employment
benefits. More public services
could be provided for free
Cut public expenditure Public sector workers could A cut in public spending on capital projects, such
suffer pay cuts or be made as road and school building, will cause cutbacks in
unemployed. Welfare benefits the construction industry. Subsidies paid to other
may be reduced firms may be cut.
Monetary policy involves varying the interest rate charged by the central bank for lending money to the banking system
in an economy.
Contractionary monetary policy may be used to reduce price inflation by increasing the interest rate. Because banks
have to pay more to borrow from the central bank they will increase the interest rates they charge their own customers for
loans to recover the increased cost. Banks will also raise interest rates to encourage people to save more in bank deposit
accounts so they can reduce their own borrowing from the central bank.
As interest rates rise, consumers may save more and borrow less to spend on goods and services. Firms may also
reduce the amount of money they borrow to invest in new equipment. A reduction in capital investment by firms will
reduce their ability to increase output in the future. Higher interest rates may therefore reduce economic growth and
increase unemployment.
Expansionary monetary policy may be used during an economic recession to boost demand and employment by
cutting interest rates. However, increasing demand can push up prices and may increase consumer spending on imported
goods and services.
The foreign exchange rate of Firms borrow less to invest in new capital equipment,
the national currency may rise. which may harm economic growth.
This will reduce the prices of
imports Prices of exports sold overseas will rise if the
exchange rate increases. Exporting firms may suffer
Consumers may buy more falling demand and profits.
imports instead of home-
produced goods and services
Cut interest rates Spending rises as saving Firms increase output and demand more labour as
becomes less attractive and demand rises.
borrowing less expensive
Firms may increase investment
The exchange rate may fall
causing imported inflation Prices of exports sold overseas may fall if the
exchange rate rises. Demand for exports may rise.
Supply-side policies aim to increase economic growth by raising the productive potential of the economy. An increase in
the total supply of goods and services will require more labour and other resources to be employed, will reduce market
prices, and provide more goods and services for export. Supply-side policy instruments aim to encourage firms and
employees to become more productive, and to remove any barriers that may prevent this.
a. Explain the four main macroeconomic objectives and why they may be in conflict with each other.
b. Explain how taxation and government spending intend to change an economy.
c. Explain how interest rates and the supply of money may alter an economy.
d Discuss whether governments should use spending, taxation, interest rates or supply side policies to rebalance an
economy in recession or boom. [This is a common 10 mark question.]
Taxation
A public sector is a major employer, producer and consumer in many modern economies. For example, the public sector
in France employs 22% of the workforce.
Public sector organizations include:
• National, regional and local government authorities and their administrative departments and offices
• Government agencies that run services such as the Child Support Agency and Prisons Service in the UK
• Public corporations
To pay the running costs of government organizations and for the goods and services they consume or provide the public
sector must raise revenue. Tax revenue is the main source of public sector finance in most countries.
Public expenditures are financed by taxes and other revenues. Most revenue is raised from taxation. Taxes are used by
governments to help them achieve a number of objectives:
• To finance public expenditure
• To reduce inequalities in income and wealth through a progressive tax system.
• To discourage the consumption of harmful products, such as cigarettes, by raising their prices
• To protect the environment by discouraging damaging and polluting activities, for example, by taking gasoline,
carbon emissions and landfill waste
• To achieve macro-economic objectives using fiscal policy.
Direct taxes are levied on their income or wealth of an individual or company, including:
• Personal income tax is levied on income including on interest payments on savings
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• Payroll taxes include personal income taxes collected by employers from the wages of their employees , and the
taxes an employer pays from their own funds related to employing workers, including social security contributions
• Corporation tax is levied on company profits. Small companies with low profits can often be made exempt, or pay
a zero rate of tax, to encourage enterprise.
• Capital gains tax is a tax on any gain in value from the sale of assets held by individuals and companies such as
shares and bonds, precious metals and property
• Transfer taxes are applied to the transfer of assets from one person to another. They include gift taxes, estate
taxes and inheritance taxes paid on inherited wealth.
Advantages of direct taxes Disadvantages of direct taxes
• They are a major source of tax revenue • Incomes taxes can reduce work incentives
• Many are progressive and help to reduce • Taxes on profits reduce profit available to
inequalities in incomes after tax entrepreneurs to re-invest in their businesses
• They take account of people’s ability to pay • High tax rates can cause tax evasion
a. Explain the main methods a government can use to raise finances for its spending.
b. Explain how taxation policy can be used to redistribute income effectively.
c. Explain the differences between various types of taxation in an economy.
d. Explain the main objectives for governments’ use of taxation.
e. Discuss whether governments are always able to achieve their main goals when using the various types of taxation
systems today. [It is a hard question and perhaps would not appear in this style. In reality it may appear broken
down into something smaller, such as discuss whether proportional taxation is always effective. However, attempt to
answer this as if it’s worth 10 marks.]
Initially households spend money on goods and services produced by firms. Households get the money to buy these
goods and services by supplying the factors of production (land, labour, capital and enterprise).
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ADDING TO THE CIRCULAR FLOW AND THE VALUE OF THE ECONOMY
- Businesses may invest money into new equipment or new factories. This allows extra production to take place.
- The Government may spend £100 mn on a roadbuilding project. This creates economic activity
- An export is a sale of a good or service to a foreigner. This brings money into the economy.
Savings mean that people are not spending money on goods and services
Taxes are taken out of peoples and businesses incomes. This money cannot be spent on goods and services.
Imports are purchases from abroad. The money leaves the country
a. Try to draw the full circular flow without looking at the diagram
b. Explain what is meant by aggregate demand and what the various components are. [5 marks].
c. If there is an addition of £3million (govt spending or investment) into the circular flow it may create £9 million of
economic activity. This is a multiplier of 3. How does this happen?
Economic growth
Total value of all goods and services produced in an economy is known as the national output.
Factors of production are paid by firms to produce the national output, and owners of firms earn profits if they are
successful. The total income earned in an economy is the national income.
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People use their incomes to buy goods and services. The total amount spend on the national output of an economy is the
national expenditure. Therefore National output = national income = national expenditure. Each is identical
Gross Domestic Product (GDP) is a measure of national income and output. This is the main measure of the
national income or output of an economy used by governments and economists. It measures the final value of all goods
and services produced within an economy over a given period of time, usually per year.
An increase in prices will increase nominal GDP but people will be no better off because increasing prices reduce the
purchasing power of their incomes.
People will only be better off if there is an increase in real GDP because the total output of goods and services will have
increased.
Economic growth occurs as real national income and output expands, i.e. if there is a rise in real GDP.
Most governments want to achieve stable long-term growth in the real GDP of their economies. Plotted against time this
would look like a steadily rising line. However, the rate of growth in real GDP may not be very stable over time.
This is measured by the yearly change in Gross Domestic Product (GDP). It is usually expressed as a % change.
Example: Year 1 Tinseltown produces £1,000 worth of goods. Year 2 Tinseltown produces £1,100 worth of goods.
Economic growth would be 10%
The business cycle or economic cycle refers to the patterns of ups and downs (or ‘cyclical fluctuations’) observed in real
GDP growth over time in many economies.
Anything which allows the country to produce more goods and services. • More business investment * Better productivity •
Better machinery * Improved training • Better skills * New technology • New ideas * Increased efficiency
BENEFITS: More income for society, Should create jobs, Could reduce the number of poor people, More goods produced
and probably more choice for customers and businesses, Higher standard of living, Feel good factor in society
COSTS: Extra production could cause extra pollution, Exhaustion of non renewable resources like oil, Only the rich may
gain the benefits The poor stay poor and inequality increases, Greater stress on workers to produce more goods.
The economy tends to experience different trends. These can be categorised as the trade cycle and may feature boom,
slump, recession and recovery. BOOM: A period of fast economic growth. Output is high due to increased demand,
unemployment is low. Business confidence may be high leading to increased investment. Consumer confidence may lead
to extra spending. SLUMP: A period when output slows down due to a reduction in demand. Confidence may begin to
suffer. RECESSION: A period where economic growth slows down and the level of output may actually decrease.
Unemployment is likely to increase. Firms may lose confidence and reduce investment. Individuals may save rather than
spend. RECOVERY: A period when the economy moves between recession and a boom.
Economic boom: demand for goods Economic recession: real GDP falls.
and services rises faster than output can Demand for goods and services falls.
rise. Profits peak and prices rise as Firms cut their production and lay off
economy ‘overheats’ workers. Profits and other incomes fall
a. For each cause of economic growth. Try to think why it would allow businesses and the economy to produce a
greater number of goods and services.
b. For each cost and benefit. Try to think through why it is in reality a cost or benefit.
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The causes of unemployment
Falling demand for goods and services is a major cause of unemployment is cyclical unemployment occurs during an
economic recession due to falling consumer demand for goods and services and falling incomes. Firms will reduce their
output and lay off workers.
Unemployed workers may only find new jobs as demand recovers. A government may try to boost demand using fiscal
and monetary policies.
Structural unemployment is caused by changes in the industrial structure of an economy. e.g. In the UK; 1980/ 90’s
Deindustrialisation – coal mining, shipbuilding, or the airline industry. Entire industries may decline and close due to a
permanent fall in demand for their goods or services. This can cause prolonged regional unemployment if most firms in
the industry were located in one particular area, for example, to be close to a supply of raw materials.
Many countries have experienced structural change as old primary and secondary industries such as mining, shipbuilding
and textiles have declined. Workers made redundant from these industries will have skills that are no longer needed. They
may be unemployed for a long period of time unless they retrain in skills required by new and growing industries.
Technological progress has also caused structural change and unemployment in some industries. Labour has been
made redundant as production lines have been mechanized and as consumer demand for the, technologically advanced
products has risen.
Frictional unemployment refers to short-lived unemployment that occurs when people leave jobs they dislike, move to
higher paid jobs, move home or are made redundant.
Seasonal unemployment occurs because consumer demand for some goods and services changes with the seasons.
For example, unemployment among workers in tourist and construction industries tends to rise in winter but fall during
summer months.
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Employment and Unemployment
Most governments have an objective to maintain a high and stable level of employment in their economies, and a low
level of unemployment. Employment provides incomes. In contrast, unemployment is a waste of productive resources. It
is not surprising, therefore, that government officials and people planning their future careers will be very interested in
monitoring employment trends. Employment trends are monitored closely by government and economists. An increase
in the labour force or working population in a country means more goods and services can be produced. However, not
everyone of working age will be willing or able to work. They may have the wrong skills or there may not be enough full-
time jobs for them. Rising employment is a sign that an economy is healthy and growing. Rising unemployment, however,
is a sign that economic conditions are deteriorating.
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• Unemployed people may become depressed and ill. This can put a strain on their family relationships and local
health services.
Reducing unemployment
This is a key target for all governments. High unemployment has enormous costs for individuals, businesses, the
Government and the economy.
• Government support to struggling industries in order to try to save jobs e.g. airline industry
• Provide more training and education to the unemployed. This could help improve computer skills and communication.
These people will become more confident and employable.
• Try to bring the country out of a recession. The Government needs to try to create demand in the economy. It could;
• The new deal in some economies: at present an individual is only allowed to claim unemployment benefit for 6 months.
After 6 months they must take any job, which is offered to them or accept a loss of benefit.
a. Why do you think the new deal was introduced? Do you agree with this policy?
b. How could a road building project help create jobs?
c. What information could be made available in job centres?
e. Discuss whether cuts in interest rates or income tax would always ‘kick-start’ the economy? [6 marks]
f. Discuss whether the government of a country can effectively reduce all types of unemployment. [10 marks]
Inflation
Inflation is a continuous or sustained rise in the general level of prices of goods and services in an economy.
The rate of price inflation is measured by calculating the average percentage change in price per period of time, usually
per month or each year.
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A consumer price index (CPI) is a measure of price inflation affecting consumers. It is calculated from the movement in
the average price of a ‘basket’ of goods and services purchased by the ‘typical’ household in a country from a
sample of different retail outlets.
The proportion of total household expenditure spent on each good or service is used to weight their individual prices. For
example, if the price of a loaf of bread is $2 and the typical household spends 5% of their weekly or annual spending on
bread, then the weighted average price will be $2 x 0.05= $0.10. Prices are weighted in this way because the more a
household spends on a particular good or service the more an increase in the price of that product will matter.
In the first year of measurement-the base year- the weighted average price of all goods and services in the CPI basket is
calculated and set equal to 100. Monthly or annual changes in the weighted average price of the basket are then
compared to the base year.
Year 2
Products Average price ($) Proportion of Weighted Price index
household average price ($)
expenditure
spend on each
product (%)
Food $70 60% 0.60 x $70=$42
Travel $40 15% 0.15 x $40=$6
Clothing $48 25% 0.25 x $48=$12
Cost and demand pressures cause inflation. There are three main causes of price inflation:
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• Demand-pull inflation is caused by total demand rising faster than the total output of goods and services,
causing market prices to rise.
• Cost-push inflation is caused by an increase in the cost of producing goods and services, for example, from
higher wages or raw material prices. Firms will try to pass these costs onto consumers through higher prices.
• Imported inflation results from rising prices of goods and services imported from overseas. This can be due to
an increase in the costs of overseas producers and/or a fall in the exchange rate of the currency of the importing
country.
• Monetary inflation happens as a result of the interest rate falls and money supply rises (sometimes from the
central bank printing money and buying bonds, called quantitative easing). Consumption rises and businesses or
individuals borrow more from commercial banks. This all enables businesses to raise prices assuming they can
get away with it due to more money existing in the economy.
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importing • Print less money
• Reduce tariffs and quotas on imports that are more • Withdraw some money from circulation.
expensive at the moment
Each of the above approaches has its advantages and
disadvantages.
Some policies are effective but will be unpopular with consumers and may cause a minor recession, and also take a long
time. Other policies could be effective but it is very difficult for the government to tell private firms how much to charge for
inputs and also how much to pay their workers. The problems also arise due to actually knowing what caused the inflation
in the first place.
a. Think of 3 or 4 goods that you buy regularly. What inflation have you experienced i.e. how have the prices changed
over recent years?
b. Which of the problems do you believe is the greatest a) to individuals b) to businesses c) to the economy.
c. In the cost push example, why are workers demanding higher wages?
d. How does a ticket tout use demand pull to increase their ticket prices?
e. How could a demand and supply diagram show demand pull inflation?
f. Explain the various types of inflation, with examples of each one. [8 marks]
g. Explain how inflation is measured in an economy. [6 marks]
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