AS Macroeconomics - The Economic Cycle (April 2015)

AS Macro-Economics - March 2015
AS Macro-Economics Revision Workshop
March 2015
Revision Support
Geoff Riley @tutor2u_econ
Website: www.beta.tutor2u.net
Page 3

Linda Yueh
@lindayueh
Robert Peston
@Peston
Kamal Ahmed
@BBCkamal
Keep following the business and
economics news as part of your revision!

AS Macro-Economics Revision Workshop
March 2015
Session 1:
Aggregate Demand, Aggregate Supply
and the Economic Cycle
Page 3

Page 11

Recession in
Ireland
Fall in
demand for
Irish imports
Inward shift
in demand
for UK
exports
Fall in
aggregate
demand
Contraction
of short run
aggregate
supply

Recession in
Ireland
Fall in
demand for
Irish imports
Inward shift
in demand
for UK
exports
Fall in
aggregate
demand
Contraction
of short run
aggregate
supply
AD2
Y2

Recession in
Ireland
Fall in
demand for
Irish imports
Inward shift
in demand
for UK
exports
Fall in
aggregate
demand
Contraction
of short run
aggregate
supply
AD2
Y2
Evaluation
Significance of Ireland as an
export market for the UK

Awareness
Low productivity is one of the
most important supply-side
problems facing the UK

Improved
efficiency
Causes fall in
unit costs
Outward
shift of
aggregate
supply
Fall in the
price level
Expansion of
aggregate
demand
Awareness

Improved
efficiency
Causes fall in
unit costs
Outward
shift of
aggregate
supply
Fall in the
price level
Expansion of
aggregate
demand
SRAS2
Y2
Awareness

Analysis
A rise in VAT would be an
example of fiscal austerity –
designed to raise revenues

VAT is a tax
on
producers
Inward shift
of aggregate
supply
Rise in the
general price
level
Fall in real
incomes of
consumers
Contraction
of aggregate
demand
Analysis

VAT is a tax
on
producers
Inward shift
of aggregate
supply
Rise in the
general price
level
Fall in real
incomes of
consumers
Contraction
of aggregate
demand
SRAS2
Y2
P2
Analysis

Knowledge
What is the difference
between a budget deficit and
the national debt?

Budget
deficit – G is
> than T
Injection of
aggregate
demand
Outward
shift of AD
Expansion of
real GDP
Might also
cause higher
prices
Knowledge
the national debt?

Budget
deficit – G is
> than T
Injection of
aggregate
demand
Outward
shift of AD
Expansion of
real GDP
Might also
cause higher
prices
Knowledge
the national debt?
AD2
Y2

In AS Macro it is really
important to ALWAYS have in
mind the key objectives of
macro economic policy
Refer back to them frequently

Page 3
Price Stability – i.e. Low
Positive Inflation
(CPI Inflation of 2%)
Sustainable Growth of
Real GDP (National
Output)
Falling Unemployment
Higher Average Living
Standards (real national
income per capita)
Improved
Competitiveness / Trade
Performance
Equitable Distribution of
Income and Wealth

Boom
Slowdown
Recession
Recovery
A cycle is when GDP growth fluctuates around the trend (or underlying) growth

Gross domestic product (GDP) growth rate in the United Kingdom 2018
UK Real gross domestic product (GDP) growth rate from 2008 to 2018
(compared to the previous year)
Note: Great Britain
-0.77%
-5.17%
1.66%
1.12%
0.28%
1.74%
3.21%
2.71%
2.44% 2.39% 2.42%
-6.0%
-5.0%
-4.0%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
2008 2009 2010 2011 2012 2013 2014* 2015* 2016* 2017* 2018*
GDPgrowthratecomparedtopreviousyear

AGGREGATE DEMAND =
C I G X M
CONSUMER
EXPENDITURE
INVESTMENT
GOVERNMENT
SPENDING EXPORTS IMPORTS
Page 3

(% change) 2008 2009 2010 2011 2012 2013 2014 2015 2016
Consumption -0.8 -4.2 1.1 0.4 1.3 1.7 2.9 2.6 2.5
Investment -4.7 -14.4 5.9 2.3 0.7 3.2 8.1 7.1 7.6
Government
Spending
2.0 1.2 0.0 0.0 2.3 0.7 1.0 -0.5 -1.2
Import volumes 1.6 -8.2 6.2 5.6 0.7 0.5 -1.3 1.2 2.4
Export volumes -1.8 -9.8 8.7 1 3.1 0.5 -1.6 1.2 2.2
UK Aggregate Demand Components:
Page 4
Forecast

Data Interpretation
Page 4
2009 sees a decrease in each
component apart from
government spending (which
increased by 1.2%). For
example, capital investment
decreased by 14.2%.
The figures do not follow a
constantly increasing or
decreasing trend for any of
the components. For
example, consumption and
investment increased in 2014
(by 2.9% and 8.1%) whereas
import and export growth
decreased (1.3% and 1.6%).
Significant feature 1 Significant feature 2

Spending on R&D as percentage of GDP
Page 6
Source OECD, 2014
South Korea Germany USA
4.01 2.91 2.79
France China UK
2.26 1.99 1.72

1.72% 0.69% 2.2% 3.4% 1.75%
Higher or
Lower?Lower
Higher or
Lower?Higher
Higher or
Lower?Higher
Higher or
Lower?Higher
UK GREECE BELGIUM SWEDEN IRELAND
Source OECD, 2014
Start:
R&D Higher or Lower!
Page 6

Foreign investment into the UK Economy

Page 6
Global FDI position in the United Kingdom (UK) 2004-2013
Total value of global foreign direct investment (FDI) in the United
Kingdom from 2004 to 2013 (£ billion)
Note: United Kingdom; 2004 to 2013
363.42
488.21
580.31
620.42
660.37 681.27
725.56
792.66
960.09 975.43
0
200
400
600
800
1000
1200
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
ForeigndirectinvestmentinbillionGBP
£1,000m = £1 trillion

Nissan, Sunderland Cummins Power Generation, Ramsgate
AkzoNobel, Ashington Siemens, Hull
Examples of foreign direct investment into the UK

Exam Question: To what extent is inward investment
important to the UK economy?
Page 7
Reason why it is important: Critical evaluation
1. Inward FDI can lead to
higher real GDP growth
2. FDI creates more jobs
without the need for
increased government
spending and borrowing.
1. Capital intensive FDI may
not lead to a sizeable
boost to jobs for home-
economy workers.
2. Profits from FDI may be
remitted overseas or the
corporation tax avoided
Support with a good analysis diagram!

Awareness
The “Google Tax” is
expected to raise
an extra £300-
£400m each year
from 2016 onwards
This is a small
figure in
comparison to the
main sources of tax
revenue such as
income tax and VAT

Page 7 & 8
Look at these factors that affect aggregate demand. Which two
have the biggest impact on consumption and investment and why?
Disposable income
falls
A decrease in VAT
An increase in income
tax
An increase in savings
rate
A decrease in interest
rates
A decrease in
investment by private
sector firms
A decrease in
Government
spending on the
Armed forces
Exchange rate
increases
Trade agreements
with BRIC nations
Increased productive
and allocative
efficiency in MINT
nations
Increased spending
on the NHS
A decrease in income
tax
An increase in
investment by UK car
manufacturers
An increase in
Government
spending on overseas
aid
An increase in
unemployment
A decrease in the
saving rate
An increase in the
minimum wage
A slump in the
housing market
Financial crisis in the
USA
An increase in VAT
Exchange rate
decreases
An increase in
interest rates
A reduction in
confidence by
consumers
A general increase in
share prices
Continued recession
in Eurozone area

Fall in the rate of income tax
A reduction in the basic rate of
income tax will increase the
disposable incomes of millions
of people in work
Which impact on consumption? Why is this most significant?
Increase in the minimum wage
Raising the take home pay of
lower-paid workers, many of
whom a high propensity to
consume any extra income
Page 7 & 8

Real
Disposable
Income
(i.e. Income
adjusted for
inflation &
after direct
taxes and
benefits
Employment
and Job
Security
When
employment is
rising,
confidence and
incomes may
improve
Household
Wealth
(House prices,
share prices) –
a rise in wealth
can boost
consumer
demand
Expectations
and Sentiment
The state of
confidence or
pessimism is
known as
animal spirits
Market
Interest Rates
Interest rates
affect the
incentive to
save and the
cost of
borrowing
Key factors affecting consumer spending (macro)

Decrease in interest rates
Makes borrowing less expensive
and therefore makes potential
investment projects more
profitable.
Which impact on investment? Why is this most significant?
Continued recession in the
Eurozone area
A fall in UK exports to the Euro
Zone will cause a rise in spare
capacity and lower profits –
both leading to less investment
Page 7 & 8

Page 8
Expectations play a key role
for businesses
Macroeconomic uncertainty
hits planned investment
Actual &
expected
demand
Expected
profits and
business
taxes
Interest rates
+ availability
of finance
Business
confidence
Key factors affecting investment (macro)

AS Macro:
Evaluation
Question
Evaluate the view that a
continued fall in the value
of the Euro has the largest
impact upon aggregate
demand in the UK

Evaluate the view that a continued fall in the value of the Euro has the
largest impact upon aggregate demand in the UK. Argument 1:
Point
Analysis
Evaluation
Fall in value of Euro makes European imports
cheaper in the UK.
A depreciation of the Euro means that imported
products purchased from Euro Area countries
will cost less. This will cause UK consumers to
switch their spending to overseas products
Consumers make decisions on non-price factors
too such as product quality / brand reputation
Page 9

Fall in the Euro will hit UK exporters causing a
negative multiplier effect on AD
British exporters will find it hard to sell to EU
markets and Europe is our biggest export
market. A fall in exports will cause a negative
multiplier effect leading to a big decline in GDP
1. Exporters might be able to switch towards
export markets of other regions such as Asia
2. The pound may have fallen against other
currencies such as the US dollar
Page 9
Point
Analysis
Evaluation

The fall in the Euro might only be a temporary
change in the exchange rate
Weakness of the Euro reflects the economic
difficulties of many EU countries such as Greece
and Spain; these countries will recover in time
The Euro is likely to be a weak currency for
some time to come, so British firms will need to
think longer term about how to become more
competitive
Page 9
Point
Analysis
Evaluation

International (External) Competitiveness
External competitiveness is the ability to sell goods and services at
competitive prices in a foreign country
• Cost competitiveness – differences in unit costs between
producers – reflected in prices
• Non-price competitiveness – product quality, design,
reliability and performance, choice, after-sales services,
marketing, branding and the availability and cost of
replacement parts
• Non-wage costs:
• Costs of meeting environmental / health regulations
• Environmental taxes e.g. carbon taxes and waste taxes
• Employment protection laws and health and safety laws
• Requirements to provide pensions for employees

Policies to Improve International Competitiveness
Improving Labour Markets
• Investment in education , management
• Encouraging inward migration of skilled workers
Infrastructure Investment
• Better motorways, ports, hi-speed rail
• Communications e.g. super-fast broadband, 4G
Supporting Enterprise / Entrepreneurship
• Improved access to business finance
• Incentives for innovation and invention
Macroeconomic Stability
• Maintaining low inflation / price stability
• A sustainable banking system

AS Macroeconomics - The Economic Cycle (April 2015)

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