(BQ) Part 2 book Economics has contents: The national economy; macroeconomic issues and analysis - an overview; fiscal and monetary policy; long term economic growth; long term economic growth; the balance of payments and exchange rates; economics of developing countries; global and regional interdependence;...and other contents.
www.downloadslide.com Part E Foundations of Macroeconomics 14 The National Economy 400 15 Macroeconomic Issues and Analysis: An Overview 430 16 Macroeconomic Issues, Debates and Controversies 463 Why economies sometimes grow rapidly, while at other times they suffer from recession? Why, if people want to work, they sometimes find themselves unemployed? Why economies experience inflation (rising prices), and does it matter if they do? Why exchange rates change and what will be the impact of such changes on imports and exports? Why individuals, firms and governments borrow and what are the implications of borrowing and debt for the economic health of countries? These macroeconomic issues affect all countries, and economists are called on to try to find explanations and solutions In the next three chapters we will be looking at these issues and giving you a preliminary insight into the causes of these problems and what governments can to tackle them In the third of these chapters (Chapter 16) we shall see how macroeconomics has developed over the years as economists have sought to explain the macroeconomic problems of the time – right up to the financial crisis and recession of recent years M14_SLOM4772_09_SE_C14.indd 399 11/13/14 2:17 PM www.downloadslide.com Chapter 14 The National Economy C HAP T E R MA P 14.1 The scope of macroeconomics 401 Macroeconomic debates The major macroeconomic issues Government macroeconomic policy 401 401 404 14.2 The circular flow of income 405 The inner flow, withdrawals and injections The relationship between withdrawals and injections The circular flow of income and the four macroeconomic objectives Equilibrium in the circular flow 406 407 14.3 Measuring national income and output 408 The three ways of measuring GDP Taking account of inflation Taking account of population: the use of per capita measures Taking account of exchange rates: the use of PPP measures Do GDP statistics give a good indication of a country’s standard of living? 408 409 407 408 409 410 410 14.4 Short-term economic growth and the business cycle 414 The distinction between actual and potential growth Economic growth and the business cycle The business cycle in practice Causes of fluctuations in actual growth 414 416 416 417 14.5 Long-term economic growth 419 Causes of long-term growth Policies to achieve growth Postscript: The role of investment 419 424 424 Appendix: Calculating GDP 425 The product method of measuring GDP The income method of measuring GDP The expenditure method of measuring GDP From GDP to national income Households’ disposable income 425 426 427 427 428 M14_SLOM4772_09_SE_C14.indd 400 We turn now to macroeconomics This will be the subject of the second half of this book As we have already seen, microeconomics focuses on individual markets It studies the demand for and supply of, for example, oranges, music downloads, petrol and haircuts; bricklayers, doctors, office accommodation and computers It examines the choices people make between goods, and what determines their relative prices and the relative quantities produced In macroeconomics we take a much broader view We examine the economy as a whole We still examine demand and supply, but now it is the total level of spending in the economy and the total level of production In other words, we examine aggregate demand and aggregate supply We still examine output, employment and prices, but now it is national output and its rate of growth, national employment and unemployment, and the general level of prices and their rate of increase (i.e the rate of inflation) In this chapter, we identify the major macroeconomic objectives and have a preliminary look at the ways in which they may be related Then we focus on national income and output We look at how they are measured and what causes them to grow over time 11/13/14 2:17 PM www.downloadslide.com 14.1 THE SCOPE OF MACROECONOMICS 14.1 401 THE SCOPE OF MACROECONOMICS Macroeconomic debates Macroeconomics examines various issues affecting whole economies Many of these are the big issues on which elections are won or lost Is the economy growing and, if so, how rapidly? How can we avoid, or get out of, recessions? What causes unemployment and how can the rate be got down? Why is inflation a problem and what can be done to keep it at modest levels? What will happen to interest rates? How big a problem is government debt? Are banks lending too much or too little? If there were agreement about the answers to these questions, macroeconomics would be simpler – but less interesting! As it is, macroeconomics is often characterised by lively debate Economists can take different views on the importance of macroeconomic issues, their causes and the appropriate policy responses They can also disagree about how to analyse macroeconomic phenomena and, therefore, the approach to take in modelling macroeconomic relationships We shall be looking at these different views throughout this second part of the book This is not to suggest that economists always disagree; but they sometimes Another factor is the difficulty of forecasting what will happen It is relatively easy to explain things once they have happened Predicting what is going to happen is another matter Few economists – or anyone else – foresaw the global banking crisis, credit crunch and subsequent economic downturn of the late 2000s Even those who thought banks had too little capacity to absorb losses and were making too many risky loans could not predict exactly when a crisis would occur A crucial element in macroeconomic activity is people’s expectations If people are optimistic about the future, consumers may be more inclined to spend and firms more inclined to invest If they are pessimistic, spending may fall But what drives these expectations? Again, this is a topic of lively debate Then there is the political context Governments may be unwilling to take unpopular measures, especially when an election looms So, should they give responsibility for decisions to other bodies? In many countries, interest rates are not set by the government but by the central bank In the UK, for example, it is the Bank of England that sets interest rates at the monthly meetings of the Monetary Policy Committee So just what are the macroeconomic issues that we will be studying in the following chapters? We can group them under the following headings: economic growth, unemployment, inflation, the economic relationships with the rest of the world, the financial well-being of individuals, businesses and government and the relationship between the financial system and the economy We will be studying M14_SLOM4772_09_SE_C14.indd 401 other issues too, such as consumer behaviour and taxation, but these still link to these major macroeconomic issues and, more generally, to how economies function The major macroeconomic issues Economic growth Governments try to achieve high rates of economic growth over the long term – in other words, growth that is sustained over the years and is not just a temporary phenomenon KI To this end, governments ordinarily try to achieve stable p growth, avoiding both recessions and excessive short-term growth that cannot be sustained As we shall see in later chapters, governments around the world were not very successful in preventing a recession in 2008–9 KEY IDEA 32 Economies suffer from inherent instability As a result, economic growth and other macroeconomic indicators tend to fluctuate Table 14.1 shows the average annual growth in output by decade since the 1960s for selected countries As you can see, the differences between countries are quite substantial ‘Newly industrialised countries’, such as Malaysia, Singapore and China, have experienced particularly rapid rates of economic growth There are also big differences between the growth rates of individual countries in different periods Look, for example, at the figures for Japan From being an ‘economic miracle’ in the 1960s, Japan by the 1990s had become a laggard, with a growth rate well below the OECD average Unemployment Reducing unemployment is another major macroeconomic aim of governments, not only for the sake of the unemployed themselves, but also because it represents a waste of human resources and because unemployment benefits are a drain on government revenues KI Unemployment in the 1980s and early 1990s was signifi- p cantly higher than in the 1960s and 1970s (see Table 14.1) Then, in the late 1990s and early 2000s, it fell in some countries, such as the UK and USA In others, such as Germany and France, it remained stubbornly high However, the Definition Rate of economic growth The percentage increase in national output, normally expressed over a 12-month period 11/13/14 2:17 PM www.downloadslide.com 402 CHAPTER 14 THE NATIONAL ECONOMY Table 14.1 Economic growth (average % per annum), unemployment (average %) and inflation (average % per annum) France Growth 1960 5.6 1970 3.7 1980 2.3 1990 1.9 2000 1.3 2010–15c 1.1 Unemployment 1960 1.5 1970 3.7 1980 8.2 1990 10.1 2000 8.8 2010–15c 10.4 Inflation 1960 3.8 1970 8.9 1980 7.3 1990 1.9 2000 1.9 1.7 2010–15c USA EU12a 2.9 2.4 2.7 2.8 1.9 1.4 4.3 3.2 3.1 3.2 1.8 2.4 5.8 3.8 2.3 2.2 1.3 0.9 5.5 3.7 2.9 2.5 1.8 1.9 1.3 1.7 2.5 3.0 4.7 4.5 2.2 4.5 9.9 8.2 5.4 7.7 4.1 6.1 7.3 5.8 5.5 8.1 2.5 4.0 9.3 10.5 8.5 11.3 5.5 9.1 2.5 1.2 −0.3 0.6 3.8 12.6 7.0 3.3 1.8 2.9 2.4 7.1 5.6 3.0 2.6 1.9 3.7 9.5 6.5 2.9 2.1 1.3 Germany Japan 4.4 3.1 1.9 2.2 0.9 1.9 10.4 5.2 4.4 1.5 0.6 1.7 0.9 2.3 6.9 7.9 9.0 5.8 3.2 4.9 2.9 2.4 1.6 1.8 UK OECDb Brazil Malaysia Singapore China 5.9 7.9 3.0 1.7 3.3 3.2 6.5 7.8 5.9 7.2 4.7 5.5 9.5 9.6 7.8 7.3 5.2 5.3 3.0 7.1 9.8 10.0 10.3 7.8 2.5 4.3 7.2 7.2 6.5 8.1 n.a n.a 5.5 5.6 9.9 6.1 n.a n.a 7.2 3.4 3.5 3.1 n.a 3.6 4.4 1.9 2.9 2.2 n.a n.a 2.7 2.8 4.0 4.1 3.1 9.2 8.9 4.4 2.7 2.0 46.1 30.6 328.1 854.8 6.9 5.8 0.8 5.5 3.6 3.7 2.2 2.3 1.2 5.9 2.8 1.9 1.5 3.4 n.a n.a 7.5 7.8 1.9 3.2 EU12 = the 12 original countries adopting the euro The Organization for Economic Co-operation and Development (an organisation of 34 major industrialised countries) c Figures from 2013 are based on forecasts a b global financial crisis and subsequent economic slowdown meant that unemployment rates were to rise generally in the late 2000s and into the early 2010s We take a preliminary look at the nature and causes of unemployment in Chapter 15 Inflation By inflation we mean a general rise in prices throughout the economy Government policy here is to keep inflation both low and stable One of the most important reasons for this is that it will aid the process of economic decision making For example, businesses will be able to set prices and wage rates, and make investment decisions with far more confidence In recent years we have tended to become used to inflation rates of around or per cent, but it was not long ago that inflation in most developed countries was in double figures Even though inflation rates rose in many countries in 2007–8 and again during 2010–11, figures remained much lower than in the past; in 1975, UK inflation reached 24 per cent During the recession of 2008–9, inflation rates fell in most countries, becoming negative (‘deflation’) in some In most developed countries, governments have a particular target for the rate of inflation In the UK the target is per cent The Bank of England then adjusts interest rates to try to keep inflation on target (we see how this works in Chapter 21) M14_SLOM4772_09_SE_C14.indd 402 The balance of payments and the exchange rate We are concerned here with a country’s foreign trade and its economic relationships with other countries A country’s balance of payments account records all transactions between the residents of that country and the rest of the world These transactions enter as either debit items or credit items The debit items include all payments to other countries: these include the country’s purchases of imports, the investments it makes abroad and the interest and dividends paid to people abroad who have invested in the country The credit items include all receipts from other countries: these include the sales of exports, inflows of investment into the country and earnings of interest and dividends from abroad The sale of exports and any other receipts earn foreign currency The purchase of imports or any other payments abroad requires foreign currency If we start to spend more Definitions Rate of inflation The percentage increase in prices over a 12-month period Balance of payments account A record of the country’s transactions with the rest of the world It shows the country’s payments to or deposits in other countries (debits) and its receipts or deposits from other countries (credits) It also shows the balance between these debits and credits under various headings 11/13/14 2:17 PM www.downloadslide.com 14.1 THE SCOPE OF MACROECONOMICS foreign currency than we earn, then the balance of payments will go into deficit If the government does nothing to correct the balance of payments deficit, the exchange rate must fall (We will show just why this is so in section 15.4.) The exchange rate is the rate at which one currency exchanges for another For example, the exchange rate of the pound into the dollar might be £1 = $1.60 A falling exchange rate (e.g from $1.60 to $1.50) is a problem because it pushes up the price of imports and may fuel inflation Also, if the exchange rate fluctuates, this can cause great uncertainty for traders and can damage international trade and economic growth What are the underlying causes of balance of payments problems? How the balance of payments and the exchange rate relate to the other macroeconomic issues? What are the best policies for governments to adopt? We take an initial look at these questions in Chapter 15 and then examine them in more detail in Chapters 25 and 26 Sector accounts There are two main types of accounts used to show the financial position of individuals, businesses and other organisations, governments and nations The first type, known as an income and expenditure account or profit and loss account, shows flows of incomes and expenditure The second type, known as a balance sheet, shows the stock of assets and liabilities An asset is something owned by or owed to you A liability is a debt: i.e something you owe to someone else Note that it is also possible to make a separate record of the changes to a balance sheet over a given period of time, KI 24 such as a month or a year These changes are flows Thus the p 271 acquisition of assets represents an inflow to the balance sheet and the disposal of assets represents an outflow ? Is the balance of payments account an income and expenditure account or a balance sheet? There are three key accounts which are compiled for the main sectors of the economy: the household, corporate and government sectors and the economy as whole ■ ■ ■ First, there is the income account which records the various flows of income alongside the amounts either spent or saved Economic growth refers to the annual real growth in a country’s income flows (i.e after taking inflation into account) Second, there is the financial account The financial balance sheet gives a complete record of the stocks of financial assets (arising from saving) and financial liabilities (arising from borrowing) of a sector, and include things such as currency, bank deposits, loans, bonds and shares Changes in such balances over time (flows of new saving and borrowing) have been key in explaining the credit crunch and subsequent deep recession of the late 2000s/early 2010s Third, there is the capital account, which records the stock of non-financial (physical) wealth, arising from acquiring M14_SLOM4772_09_SE_C14.indd 403 403 or disposing of physical assets, such as property and machinery Changes over time (inflows and outflows) in the capital balance sheets of the different sectors give important insights into relationships between the sectors of the economy and to possible growing tensions The national balance sheet is a measure of the wealth of a country It can be presented so as to show the contribution of each sector and/or the composition of wealth The balance of a sector’s or country’s stock of both financial and non-financial wealth is referred to as its net worth Figure 14.1 presents the national balance sheet for the UK since 1987 In 2012, the net worth of the UK was £7.27 trillion, equivalent to 4.6 times the country’s annual income or ‘gross domestic product (GDP)’ (see section 14.3 on the measurement of GDP) The stock of net worth fell for two consecutive years – 2008 and 2009 – at the height of the financial crisis and the economic slowdown These various accounts are part of an interconnected story detailing the financial well-being of a country’s households, corporations and government To illustrate how, consider what would happen if, over a period of time, you were to spend more than the income you receive This would result in your income account deteriorating To finance your excess spending you could perhaps draw on any financial wealth that you have accumulated through saving Alternatively, you might fund some of your spending through a loan from a financial institution, such as a bank Either way, your financial balance sheet will deteriorate Or you may dispose of some physical assets, such as property In this scenario your capital balance sheet will deteriorate But however your excess spending is financed, your net worth declines The importance of balance sheet effects in influencing behaviour and, hence, economic activity has been increasingly recognised by both economists and policy makers, especially since the financial crisis of 2007–9 Yet there remains considerable work to be done in gaining a better understanding of the relationship and in devising the most appropriate policies Definitions Exchange rate The rate at which one national currency exchanges for another The rate is expressed as the amount of one currency that is necessary to purchase one unit of another currency (e.g €1.20 = £1) Income and expenditure account or profit and loss account A record of the flows of incomes, expenditure and saving of an individual or institution Balance sheet A record of the stock of assets and liabilities of an individual or institution Asset Possessions of an individual or institution or claims held on others Liability Claims by others on an individual or institution; debts of that individual or institution Net worth The market value of a sector’s stock of financial and non-financial wealth 11/13/14 2:17 PM www.downloadslide.com 404 CHAPTER 14 THE NATIONAL ECONOMY Figure 14.1 UK net worth Source: Based on data from National Balance Sheet and Quarterly National Accounts (National Statistics) KEY IDEA 33 Balance sheets affect people’s behaviour The size and structure of the liabilities and assets of governments, institutions and individuals affect economic well-being and can have significant effects on behaviour and economic activity Government macroeconomic policy From the above issues we can identify a series of macroeconomic policy objectives that governments might typically pursue: ■ ■ Financial stability A core aim of policy makers is to ensure the stability of the financial system After all, financial markets and institutions are an integral part of economies Their well-being is crucial to the well-being of an economy and, because of the global interconnectedness of financial institutions and markets, problems can spread globally like a contagion The financial crisis of the late 2000s showed vividly how financially distressed financial institutions can cause serious economic upheaval on a global scale It perhaps seems self-evident, but a model of the macroeconomy is incomplete if it does not just incorporate financial markets and institutions but also capture the interaction between the financial system and the macroeconomy As we shall see in Chapter 18, a major part of the global response to the financial crisis has been to try to ensure that financial institutions are more financially resilient In particular, financial institutions should have more lossabsorbing capacity and therefore be better able to withstand ‘shocks’ and deteriorating macroeconomic conditions M14_SLOM4772_09_SE_C14.indd 404 ■ ■ ■ ■ High and stable economic growth Low unemployment Low inflation The avoidance of balance of payments deficits and excessive exchange rate fluctuations The avoidance of excessively financially distressed sectors of the economy, including government A stable financial system Unfortunately, these policy objectives may conflict For example, a policy designed to accelerate the rate of economic growth may result in a higher rate of inflation, a balance of payments deficit and excessive lending Governments are thus often faced with awkward policy choices KEY IDEA 34 Societies face trade-offs between economic objectives For example, the goal of faster growth may conflict with that of greater equality; the goal of lower unemployment may conflict with that of lower inflation (at least in the short run) This is an example of opportunity cost: the cost of achieving one objective may be achieving less of another The existence of trade-offs means that policy makers must make choices 11/13/14 2:17 PM www.downloadslide.com 14.2 THE CIRCULAR FLOW OF INCOME 405 Section summary Macroeconomics, like microeconomics, looks at issues such as output, employment and prices; but it looks at them in the context of the whole economy Macroeconomics is often characterised by debates These debates arise because macroeconomists hold different views of how economies work Amongst the macroeconomic goals that are generally of most concern to governments are: economic growth, 14.2 reducing unemployment, reducing inflation, avoiding balance of payments and exchange rate problems, avoiding excessively financially distressed economic agents and ensuring a stable financial system Unfortunately, these goals are likely to conflict Governments may thus be faced with difficult policy choices THE CIRCULAR FLOW OF INCOME One way in which the macroeconomic objectives are linked is through their relationship with aggregate demand (AD) This is the total spending on goods and services made within the country (‘domestically produced goods and services’) This spending consists of four elements The first is consumer spending on domestically produced goods and services (Cd) (i.e total consumer expenditure on all products (C) minus expenditure on imports (M)) The Definitions Aggregate demand Total spending on goods and services produced in the economy It consists of four elements: consumer expenditure (C ), investment (I ), government expenditure (G) and the expenditure on exports (X), less any expenditure on foreign goods and services (M ) Thus AD = C + I + G + X − M, or Cd + I + G + X Consumption of domestically produced goods and services (Cd) The direct flow of money payments from households to firms Figure 14.2 M14_SLOM4772_09_SE_C14.indd 405 other three elements are: investment expenditure by firms (I ), government spending (G) and the expenditure by residents abroad on this country’s exports (X ) Thus,1 AD = Cd + I + G + X or, put another way, AD = C + I + G + X − M To show how these objectives may be related to aggregate demand, we can use a simple model of the economy This is the circular flow of income, and is shown in Figure 14.2 It is an extension of the model that we looked at back in Chapter (page 17) In the diagram, the economy is divided into two major groups: firms and households Each group has two roles Firms are producers of goods and services; they are also the We assume, for simplicity, in this first equation that all investment, government expenditure and export expenditure is on domestic products If, however, any part of these three went on imports, we would have to subtract this imported element (as we did with consumption) We would then have to write AD = Cd + Id + Gd + Xd The circular flow of income 11/13/14 2:17 PM www.downloadslide.com 406 CHAPTER 14 THE NATIONAL ECONOMY employers of labour and other factors of production Households (which include all individuals) are the consumers of goods and services; they are also the suppliers of labour and various other factors of production In the diagram there is an inner flow and various outer flows of incomes between these two groups Before we look at the various parts of the diagram, a word of warning Do not confuse money and income Money KI 24 is a stock concept At any given time, there is a certain p 271 quantity of money in the economy (e.g £1 trillion) But that does not tell us the level of national income Income is a flow concept (as is expenditure) It is measured as so much per period of time The relationship between money and income depends on how rapidly the money circulates: its ‘velocity of circulation’ (We will examine this concept in detail later on: see pages 470 and 561.) If there is £1 trillion of money in the economy and each £1 on average is paid out as income twice per year, then annual national income will be £2 trillion The inner flow, withdrawals and injections The inner flow Firms pay money to households in the form of wages and salaries, dividends on shares, interest and rent These payments are in return for the services of the factors of production – labour, capital and land – that are supplied by households Thus on the left-hand side of the diagram, money flows directly from firms to households as ‘factor payments’ Households, in turn, pay money to domestic firms when they consume domestically produced goods and services (Cd) This is shown on the right-hand side of the inner flow There is thus a circular flow of payments from firms to households to firms and so on If households spend all their incomes on buying domestic goods and services, and if firms pay out all this income they receive as factor payments to domestic households, and if the velocity of circulation does not change, the flow will continue at the same level indefinitely The money just goes round and round at the same speed and incomes remain unchanged ? Would this argument still hold if prices rose? In the real world, of course, it is not as simple as this Not all income gets passed on round the inner flow; some is withdrawn At the same time, incomes are injected into the flow from outside Let us examine these withdrawals and injections Withdrawals (W) Only part of the incomes received by households will be spent on the goods and services of domestic firms The remainder will be withdrawn from the inner flow Likewise M14_SLOM4772_09_SE_C14.indd 406 only part of the incomes generated by firms will be paid to UK households The remainder of this will also be withdrawn There are three forms of withdrawals (or ‘leakages’ as they are sometimes called) Net saving (S) Saving is income that households choose not to spend but to put aside for the future Savings are normally deposited in financial institutions such as banks and building societies This is shown in the bottom centre of the diagram Money flows from households to ‘banks, etc.’ What we are seeking to measure here, however, is the net flow from households to the banking sector We therefore have to subtract from saving any borrowing or drawing on past savings by households to arrive at the net saving flow Of course, if household borrowing exceeded saving, the net flow would be in the other direction: it would be negative Net taxes ( T) When people pay taxes (to either central or local government), this represents a withdrawal of money from the inner flow in much the same way as saving; only, in this case, people have no choice Some taxes, such as income tax and employees’ national insurance contributions, are paid out of household incomes Others, such as VAT and excise duties, are paid out of consumer expenditure Others, such as corporation tax, are paid out of firms’ incomes before being received by households as dividends on shares (For simplicity, however, taxes are shown in Figure 14.2 as leaving the circular flow at just one point.) When, however, people receive benefits from the government, such as unemployment benefits, child benefit and pensions, the money flows the other way Benefits are thus equivalent to a ‘negative tax’ These benefits are known as transfer payments They transfer money from one group of people (taxpayers) to others (the recipients) In the model, ‘net taxes’ (T ) represents the net flow to the government from households and firms It consists of total taxes minus benefits Import expenditure (M) Not all consumption is of totally home-produced goods Households spend some of their incomes on imported goods and services, or on goods and services using imported components Although the money that consumers spend on such goods initially flows to domestic retailers, it will eventually find its way abroad, either when the retailers or wholesalers themselves import them, or when domestic manufacturers purchase imported inputs to make their products This expenditure on imports Definitions Withdrawals (W ) (or leakages) Incomes of households or firms that are not passed on round the inner flow Withdrawals equal net saving (S) plus net taxes (T ) plus import expenditure (M ): W = S + T + M Transfer payments Moneys transferred from one person or group to another (e.g from the government to individuals) without production taking place 11/13/14 2:17 PM www.downloadslide.com 14.2 THE CIRCULAR FLOW OF INCOME constitutes the third withdrawal from the inner flow This money flows abroad Total withdrawals are simply the sum of net saving, net taxes and the expenditure on imports: W=S+T+M Injections (J) Only part of the demand for firms’ output arises from consumers’ expenditure The remainder comes from other sources outside the inner flow These additional components of aggregate demand are known as injections ( J ) There are three types of injection Investment (I) This is the money that firms spend after obtaining it from various financial institutions – either past savings or loans, or through a new issue of shares They may invest in plant and equipment or may simply spend the money on building up stocks of inputs, semi-finished or finished goods Government expenditure (G) When the government spends money on goods and services produced by firms, this counts as an injection Examples of such government expenditure include spending on roads, hospitals and schools (Note that government expenditure in this model does not include state benefits These transfer payments, as we saw above, are the equivalent of negative taxes and have the effect of reducing the T component of withdrawals.) is saved, there will be more available for banks and other financial institutions to lend out If tax receipts are higher, the government may be keener to increase its expenditure Finally, if imports increase, incomes of people abroad will increase, which will enable them to purchase more of our exports These links, however, not guarantee that S = I or G = T or M = X Firms may wish to invest (I) more or less than people wish to save (S); governments can spend (G) more than they receive in taxes (T ) or vice versa; and exports (X ) can exceed imports (M) or vice versa A major point here is that the decisions to save and invest are made by different people, and thus they plan to save and invest different amounts Likewise the demand for imports may not equal the demand for exports As far as the government is concerned, it may choose not to make T = G It may choose not to spend all its tax revenues – to run a ‘budget surplus’ (T > G) Or it may choose to spend more than it receives in taxes – to run a budget deficit (G > T ) – by borrowing or printing money to make up the difference Thus planned injections ( J ) may not equal planned withdrawals (W ) ? Export expenditure (X) Money flows into the circular flow from abroad when residents abroad buy our exports of goods and services.1 Total injections are thus the sum of investment, government expenditure and exports: J=I+G+X The relationship between withdrawals and injections There are indirect links between saving and investment, taxation and government expenditure, and imports and exports, via financial institutions, the government (central and local) and foreign countries respectively If more money Definition Injections ( J ) Expenditure on the production of domestic firms coming from outside the inner flow of the circular flow of income Injections equal investment (I ) plus government expenditure (G) plus expenditure on exports (X ) Note that X would not include investment in the UK by foreign companies (i.e credits on the financial account of the balance of payments) Foreign ‘investment’ involves the acquisition of assets in the UK and thus represents an income to the previous owners of these assets It therefore represents an inflow from abroad to the household sector and thus has the effect of reducing M M14_SLOM4772_09_SE_C14.indd 407 407 Are the following net injections, net withdrawals or neither? If there is uncertainty, explain your assumptions (a) Firms are forced to take a cut in profits in order to give a pay-rise (b) Firms spend money on research (c) The government increases personal tax allowances (d) The general public invests more money in banks and building societies (e) UK investors earn higher dividends on overseas investments (f) The government purchases US military aircraft (g) People draw on their savings to finance holidays abroad (h) People draw on their savings to finance holidays in the UK (i) The government runs a budget deficit (spends more than it receives in tax revenues) and finances it by borrowing from the public (j) The government runs a budget deficit and finances it by printing more money The circular flow of income and the macroeconomic objectives If planned injections are not equal to planned withdrawals, what will be the consequences? If, for example, injections exceed withdrawals, the level of expenditure will rise: there will be a rise in aggregate demand This extra spending will increase firms’ sales and thus encourage them to produce more Total output in the economy will rise Thus firms will pay out more in wages, salaries, profits, rent and interest In other words, national income will rise The rise in aggregate demand will have the following effects upon the macroeconomic objectives: KI 34 ■ There will be economic growth The greater the initial excess of injections over withdrawals, the bigger will be the rise in national income p 404 11/13/14 2:17 PM www.downloadslide.com 408 ■ ■ ■ ■ CHAPTER 14 THE NATIONAL ECONOMY Unemployment will fall as firms take on more workers to meet the extra demand for output The rate of inflation will tend to rise The greater the rise in aggregate demand relative to the capacity of firms to produce, the more will firms find it difficult to meet the extra demand, and the more likely they will be to raise prices The exports and imports part of the balance of payments will tend to deteriorate The higher demand sucks more imports into the country, and higher domestic inflation makes exports less competitive and imports relatively cheaper compared with home-produced goods Thus imports will tend to rise and exports will tend to fall The increase in aggregate demand and its impact on income, consumption and saving will be recorded on sector income accounts These effects will impact on the financial and capital balance sheets of the various sectors and the economy as a whole An increase in national income allows economic agents to accumulate financial and non-financial assets and/or to reduce holdings of financial liabilities Exactly how the balance sheets are affected depends on the actual behaviour of economic agents ? Now consider the situation where there is an initial excess of withdrawals over injections What effect will there be on the macroeconomic objectives? Equilibrium in the circular flow When injections not equal withdrawals, a state of disequilibrium will exist This will set in train a process to bring the economy back to a state of equilibrium where injections are equal to withdrawals To illustrate this, let us again consider the situation where injections exceed withdrawals Perhaps there has been a rise in business confidence so that investment has risen Or perhaps there has been a tax cut so that withdrawals have fallen As we have seen, the excess of injections over withdrawals will lead to a rise in national income But as national income rises, so households will not only spend more on domestic goods (Cd), but also save more (S ), pay more taxes (T ) and buy more imports (M ) In other words, withdrawals will rise This will continue until they have risen to equal injections At that point, national income will stop rising, and so will withdrawals Equilibrium has been reached Section summary The circular flow of income model depicts the flows of money round the economy The inner flow shows the direct flows between firms and households Money flows from firms to households in the form of factor payments, and back again as consumer expenditure on domestically produced goods and services Not all income gets passed on directly round the inner flow Some is withdrawn in the form of net saving, some is paid in net taxes, and some goes abroad as expenditure on imports Likewise, not all expenditure on domestic firms is by domestic consumers Some is injected from outside the inner flow in the form of investment expenditure, 14.3 government expenditure and expenditure on the country’s exports Planned injections and withdrawals are unlikely to be the same If injections exceed withdrawals, national income will rise, unemployment will tend to fall, inflation will tend to rise, imports will tend to rise and exports fall The reverse will happen if withdrawals exceed injections If injections exceed withdrawals, the rise in national income will lead to a rise in withdrawals This will continue until W = J At this point, the circular flow will be in equilibrium MEASURING NATIONAL INCOME AND OUTPUT The circular flow of income is very useful as a model for understanding the working of an economy It shows how national income can increase or decrease as a result of changes in the various flows But just how we measure national income or output? The measure we use is called gross domestic product (GDP) This section shows how GDP is calculated It also looks at difficulties in interpreting GDP statistics Can the figures be meaningfully used to compare one country’s standard of living with another? The appendix to this chapter goes into more detail on the precise way in which the statistics for GDP are derived Definition The three ways of measuring GDP Gross domestic product (GDP) The value of output produced within the country over a 12-month period GDP can be calculated in three different ways, which should all result in the same figure These three methods are illustrated in the simplified circular flow of income shown in Figure 14.3 M14_SLOM4772_09_SE_C14.indd 408 11/13/14 2:17 PM www.downloadslide.com INDEX loans 455 personal 532 short-term 532 Local Enterprise Partnerships (LEPs) 699, 703 Logistic Performance Index 822 logistics 167 ‘London Club’ 825 London Stock Exchange 52, 275 – long-run 133 – 5, 152, 153 average cost curve 154, 155 – 6, 158 equilibrium of the firm 176 – 7, 179 equilibrium level of national income, growth to 673 – free-floating exchange rates 760 industry supply curve 176 – marginal cost 155 marginal social cost (LRMSC) 392 money illusion 598 neutrality of money 641 Phillips curve 613, 621, 622, 686 – production function 148 profit maximisation 228, 235 shut-down point 166 supply of capital services 271 under perfect competition 173 long-run theory of production 144 – 53 decision making in different time periods 152 – isoquant/isocost approach: optimum combination of factors 148 – 52 location 146 marginal product approach: optimum combination of factors 147 – scale of production 144 – size of whole industry 146 – Lorenz curve 286 – loss-minimising point 175 lost-benefit rate 309 low-reserve tranche range 646 Lucas, R 479, 610 M0 (narrow money) 543, 570, 571 M1 544 M2 544 M3 544, 550, 648, 650 M4 547, 548, 550 – see also broad money Maastricht Treaty 637, 651, 734, 788 – macro-prudential regulation 537, 540 macroeconomic equilibrium, shortrun 494 – 521 aggregate demand and national income (GDP), relationship between 494, 495 Z06_SLOM4772_09_SE_IDX.indd 19 business cycle (Keynesian analysis) 516 – 21 circular flow of income model 495 consumption 496 – 45° line diagram (Keynesian) 495 – injections 501 – national income determination 507 – 12 unemployment and inflation (Keynesian analysis) 513 – 16 withdrawals 499 – 501 macroeconomic issues and analysis 430 – 61 aggregate demand curve 441 – aggregate supply curve 442 – balance of payments 453 – constrained policy discretion 485 – emerging consensus up to financial crisis (2007 – 8) 484 – equilibrium 443 exchange rates 456 – financial crisis and search for a new consensus 486 – 90 government intervention 483 government policies 480 hysteresis 483 Keynesian revolution 473 – market imperfections 481 – monetarist counter-revolution 477 – new classical school 479 – 80 new orthodoxy 477 see also exchange rates; inflation; unemployment macroeconomic issues, debates and controversies 463 – 90 aggregate supply flexibility 466 – classical macroeconomics 468 – 73 current account 464 debates 464 – expectations, role of in working of the market 467 fiscal deficit 464 government budget deficits, significance of 467 growth 464 inflation 464 – macroeconomic indicators from 1900 464 policy implications 467 prices and wages flexibility 465 – unemployment 464 – macroeconomics 8, – 10, 18, 401 – balance of payments and exchange rate 402 – circular flow of income 405 – debates 401 financial stability 404 I:19 GDP calculation 425 – government policy 404 inflation 402 objectives 331 and the production possibility curve 16 – 17 sector accounts 403 – and supply-side policies 685 UK net worth 404 unemployment 401 – see also economic growth; national income and output measurement MacSharry reforms 93 Major government 438, 688 majority voting 735 Malthus, T.R 134 managed flexibility 767 managed floating 750 – 1, 765 managerial utility maximisation 228 – March, J 224, 239 marginal benefit 12, 13, 25, 129, 315 – 16 ratios 320 marginal capital/output ratio 517 marginal consumer surplus 103 marginal cost 12, 16, 129, 141 – 2, 256, 315 – 16 curve 162, 184, 186 long-run 155 ratios 320 marginal disutility of work 248 marginal efficiency of capital (MEC) 273, 419, 673 marginal physical product 136, 137, 149, 318 – 19 marginal private cost 324 marginal product approach 147 – marginal productivity approach 151, 252 – 4, 261, 263 marginal propensity to consume 497, 511 – 12 marginal propensity to import 500, 773 marginal propensity to save 499 marginal propensity to withdraw 501, 562 marginal rate of factor substitution 150 marginal rate of substitution (MRS) 109, 110, 320 – 1, 716 marginal rate of transformation (MRT) 321, 716 marginal revenue 159, 279 curve 162 product (MRP) 252, 279, 318 – 19, 327 11/13/14 2:31 PM www.downloadslide.com I:20 INDEX marginal social benefit of road usage 371 marginal social cost (MSC) 324, 371 – 2, 392 marginal tax propensity 499 marginal tax-plus-lost-benefit rate (marginal deduction rate) 308, 309 marginal utility theory 100, 101 – ceteris paribus assumption 103 demand curve for a good 105 – diamonds-water paradox 107 diminishing marginal utility 101 – 2, 104 function 103 individual’s demand curve 105 marginal benefit 105 marginal consumer surplus 103, 104 marginal cost 105, 108 marginal utility 101 – market demand curve 106 multi-commodity version and demand curve 107 – optimum combination of goods consumed 106 – optimum level of consumption 103–5 rational decision making and choices at the margin 105 time dimension 108 total consumer surplus 104 – total utility 101 – weaknesses of one-commodity version 106 mark-up pricing, average 240, 241 – market 17, 25 market allocation: government rejection 84 – market clearing 46, 479 market demand 61 schedule 36 market distortion 302 market equilibrium, determination of 46 market failures 358 market forces 389 – 90 market imperfections 464, 481 – menu costs and nominal price rigidity 481 – sources of frictions and imperfections 482 – market loans 529 market power 171, 327 – 30, 722 – market price distortion 803 market rate of interest 279 market relationships, introduction of into public sector 694 market share 201 market supply 61, 271 Z06_SLOM4772_09_SE_IDX.indd 20 market-based policies 359 – 60, 702 – market-based systems 364 market-clearing wage 262 market-oriented approach 440 market-oriented policies 424 market-oriented supply-side policies 686, 687 – 95 1980s 687 – competition, encouragement of 694 – deregulation 694 employment rises 689 – 90 free trade and free capital movements 694 – government expenditure, reduction of 688 labour power, reducing 690 – market relationships, introduction of into public sector 694 more people wishing to work 689 people work more enthusiastically 689 people working longer hours 689 Private Finance Initiative (PFI) 692 – 3, 694 privatisation 694 tax cuts 688 – 90 unemployment falls 690 USA 689 welfare reduction 691 – marketing practices 197 markets in action 60 – 96 indirect taxes 80 – market allocation: government rejection 84 – see also agriculture and agricultural policy; elasticity; time dimension markets, efficiency and the public interest 314 – 51 government failure and the case for the market 348 – 51 social efficiency 314 see also cost-benefit analysis; efficiency under perfect competition; government intervention markets, parallel or complementary 541, 542 Marx, K 107, 248 mass production 146 mass unemployment 472, 473 maternity pay and leave 263 maturity gap 532 maturity transformation 526 maximum price 55 May Committee 471 means-tested benefits 306, 309 Measuring National Well-being Programme (MNW) 412 medium of exchange 524 medium-term finance 275 medium-term financial strategy (Thatcher) 478 Menger, C 107, 348 menu costs of inflation 446, 481 – mergers 182, 199 and acquisitions (M&A) 232, 236 – 7, 276 conglomerate 232 due to opportunity 232 for economies of scale 232 for growth 232 horizontal 232, 237 for increased market valuation 232 for monopoly power 232 policy 382 – EU 384 – UK 387 and relationship between growth and profit 233 to reduce uncertainty 232 vertical 232 merit goods 331, 338 microeconomics 8, 9, 10 – 13, 18 and choice 10 command economy 20 objectives 12 – 13 and the production possibility curve 15 migration, rural-urban 819 – 20, 821 Mill, J.S 379 MINDSPACE acronym 127 minimum efficient plant size (MEPS) 156 minimum efficient scale (MES): economies of scale 156 – minimum price 55 minimum reserve ratio 640 minimum wage legislation 56, 295 minimum wage rate 259 Minsky, H 550 – Minsky moment 551, 621 ‘miracle of the Rhine’ 328 Mises, L von 348 – mixed economy 19, 26 – mixed market economy 26 – model building 27 – monetarists 476, 484 analysis 686 counter-revolution 477 – financial crisis and new consensus 487 interventionist supply-side policy 702 model 742 monetary changes and national income 566, 571 11/13/14 2:31 PM www.downloadslide.com INDEX monetarists (continued) monetary effects of changes in goods markets 573 – 4, 575 monetary policy and goods market 577 position 666 monetary base 543 – control 646 monetary changes (elasticity) 62 monetary changes and national income 561 – 72 balance sheets 565 domestic currency 565 – effect on interest rates of fluctuating demand for money 563 elastic liquidity preference curve 563 exchange rate transmission mechanism 565 – exports and imports 565 – interest rate changes 564 interest rate mechanism 567 interest rate transmission mechanism 561 – investment 563 – monetary transmission mechanisms 562 money 561, 562 – 3, 565 – money-interest link 562 – national income 565 – portfolio balance effect 567 quantity theory of money 561 velocity of circulation 567 – 71 monetary costs and benefits, private 340 monetary effects of changes in goods markets 572 – crowding out 573 – exchange rates 574 injections 572 – interest rates: responsiveness (elasticity) of demand for money to change in 573 interest rates: responsiveness (elasticity) of investment to change in 573 – money supply: exogeneity or endogeneity 575 monetary financial institutions (MFIs) 527, 550, 551, 552, 650 monetary flows, short-term 455 monetary policy 452, 640 – 56 automatic stabilisers 641 Bank of England 644 broad money supply control 648 central bank lending adjustment to banks 643, 645 central bank and monetary policy in USA 646 – constrained policy discretion 485 Z06_SLOM4772_09_SE_IDX.indd 21 European Economic and Monetary Union (EMU) 791 eurozone 650 – exchange rate 654 – expansionary 467, 490, 665 – financial crisis and monetary framework 644 fixed exchange rates 755, 774 floating exchange rates 775 – free-floating exchange rates 764 Goodhart’s law 653 inflation 641 – interest rates 648 – 55 ISLM analysis 665 – Keynesian revolution 475 – liquidity ratio 640 – monetary base control 645 – money demand 642 money supply control 640 – money supply reduction 642 national debt funding 645 normal operation of monetary framework 644 open-market operations 643 policy setting 640 public-sector deficits 641 quantitative easing 655 short-term 642 use of 654 – variable minimum reserve ratios 645 see also monetary policy and goods market; policy-making environment Monetary Policy Committee (MPC) 401, 538 – 9, 640, 644, 649, 655, 658, 660 Inflation Report 579 monetary policy and goods market 575 – 82 central bank policy 578 equilibrium 578 – financial accelerator 580 – goods and money markets 575 – 6, 579 – 81 inflation target rate 578 inflationary shock 578 interest rate differential 580 investment and saving responsiveness to interest rate changes 577 IS curve 576 – 7, 579, 580 – IS/MP model 579 – 80 MP curve 577 – 8, 579 – 81 multiplier size 577 national income effects on shifts in either or both IS/LM curves 581 national income, potential 578 monetary surprise model 479 I:21 money: balances, deficit 568 economy 17 illusion 411, 450, 596 and income, difference between 406 as indicator of aggregate demand 653 -interest link 562 – markets 527, 541 – in equilibrium 557 parallel 542 multiplier 546, 558, 647 – neutrality 479 transfers, current 454 see also banking, money and interest rates money, demand for 553 – precautionary motive 553 – rate of interest (or rate of return) on assets 554 – speculative or assets motive 553 – total demand for money 555 – transactions motive 553 – see also expectations money and goods markets 560 – 91 ADI/ASI model 582 – monetary changes in goods markets 572 – see also IS/LM model; monetary changes and national income; monetary policy and goods market money supply 543 – 53 additional deposit 545 annual rate of growth of M4 548 balance sheet 545 broad money multiplier in the UK 546 – counterparts to changes in M4 552 credit creation 545 – credit cycles and financial instability hypothesis 550 – curve: exogenous money supply 552 customers may not want to take up credit on offer 546 definitions 543 – difficulties in controlling 645 – effect of changes in 561 endogenous 551 – 2, 575 exogenous 551 – 2, 575 financial crisis and new consensus 489 flow-of funds equation 549 – 51 increases, causes of 548 – inflow of funds from abroad 549 and interest rate, relationship between 551 – liquidity ratio 546, 548 – 11/13/14 2:31 PM www.downloadslide.com I:22 INDEX money supply (continued ) multiplier calculation 547 non-bank private sector chooses to hold less cash 549 public-sector deficit 549 rise 477 – some of the extra cash may be withdrawn by the public 546 target 563, 653, 658 UK and eurozone money aggregates 544 monopolistic competition 171, 172, 173, 180, 194 – 7, 337 aggregate supply 594 assumptions 194 equilibrium of the firm 194 – government intervention 330 limitations 195 market imperfections 482 and monopoly comparison 197 non-price competition 196 and perfect competition comparison 196 – and the public interest 196 – monopoly 25, 171, 172, 181 – 7, 225, 241 advantages 184 – aggregate supply 594 aggressive tactics 182 barriers to entry 181 – bilateral 256, 258 competition 186 – competition policy 382 contestable 396 definition 181 disadvantages 184 economies of scale 181, 184 – economies of scope 181 – equilibrium price and output 182 – 4, 186 government failure and the case for the market 350 higher cost curves due to lack of competition 184 higher price and lower output 184 innovation and new products 186 international trade and development 811 intimidation 182 legal protection 182 limit pricing 183 lower cost curves due to more R&D and more investment 186 lower costs for an established firm 182 market power 327 mergers and takeovers 182 natural 181, 188, 390 – 1, 396 Z06_SLOM4772_09_SE_IDX.indd 22 network economies 181 opening up the market: Sky and football coverage 185 ownership of, or control over, key inputs 182 ownership of, or control over, wholesale or retail outlets 182 police as a public service 326 policy 382 EU 383 – UK 386 – power 272, 318, 341, 737, 754 and price discrimination 186 privatisation and regulation 391 product differentiation and brand loyalty 182 profit maximising 182 and public interest 184 – unequal distribution of income 184 union 257 – X inefficiency 186 see also monopolistic competition monopsony 256 – 7, 258, 267 power 269, 270, 272, 295, 327 Mont Pelerin Society 349 moonlighting 301, 412 moral hazard 124, 227, 534, 829 moral issues 261 mortgage-backed securities (MBS) 647 mortgages 51, 532, 534 most favoured nations clause 728 MP curve 577 – 8, 579 – 81 MPC 500, 541, 661, 663 MPP 279 MRS and MPP, relationship between 150 multi-factor case: marginal product approach 147 – Multilateral Debt Relief Initiative (MDRI) 829 multiplier: /accelerator interaction 518 bank deposits 545 – 6, 643 deflationary gap 513 deriving formula (algebraic proof) 511 effect 475 effects, global 725 – effects, regional 699, 702, 737 fiscal policy 634 – income and expenditure approach 510 – 11 Lagrangian 113, 152 normal 631 numerical illustration 510 – 11 qualifications 511 – 12 ‘round’ 510 shift in expenditure function 510 withdrawals and injections approach 507 – 10 see also under national income determination mutual agreements 232 mutual recognition 734 narrow money (M0) 543, 570, 571 Nash equilibrium 206, 210, 211, 213, 727 Nash, J 206 National Careers Service 701 national debt 626, 645, 789 national economy 400 – 28 circular flow of income 405 – GDP calculation 425 – macroeconomics 401 – short-term economic growth and the business cycle 414 – 19 see also national income and output measurement; economic growth, long-term National Health Service (NHS) 82, 694 national income 524 business cycle 517 fiscal policy 636 full-employment level 513 gross 427, 800, 801 – net 427, 428 potential 620 – statistics comparisons 411 steady-state 674 see also monetary changes and national income national income determination 507 – 12 aggregate expenditure increase 510 cumulative causation 508 equilibrium national income 507 45° line diagram and aggregate demand and supply diagram 512 injections and withdrawals 512 marginal propensity to consume domestic product 511 – 12 withdrawals, shift in 509 – 10 see also multiplier national income and output measurement 408 – 14 exchange rates: PPP measures 410 expenditure method 409 income method 409 inflation 409 national income statistics comparisons 411 national output, problems of measuring 410, 412 non-marketed items 412 11/13/14 2:31 PM www.downloadslide.com INDEX national income and output measurement (continued) population: per capita measures 409 – 10 product method 409 production of certain ‘bads’ leads to increase in GDP 412 production does not equal consumption 412 production has human costs 412 real and nominal values, distinction between 411 ‘underground’ economy 412 see also gross domestic product National Infrastructure Plan (NIP) 693 national insurance contributions (NICs) 298 National Investment Plan (NIP) 693 nationalised industries 338 – 9, 389, 390, 524, 627, 698 natural (equilibrium) unemployment 478, 630, 690 natural level of employment 597 natural level of output 597 natural monopoly 181, 188, 390 – 1, 396 natural rate of unemployment 604 see also non-accelerating-inflation rate of unemployment (NAIRU) natural resources 268 natural unemployment see equilibrium unemployment natural wastage 258 nature, random shocks and other unpredictable events 44 near money 546 negative income tax 308 negative public-sector net cash requirement (PSNCR) 549, 551 neo-Austrian economists 348, 350, 686, 702 neo-Marxist economists 813 neoclassical theory 248, 252, 319, 818 net present value of an investment 273 net stable funding ratio (NSFR) 537 net worth 403, 502 network 233 economies 181 New Approach to Public Private Partnerships 693 new classical approach 479 – 80, 484 aggregate supply 594 alternative exchange rates 742 constrained policy discretion 485 financial crisis and new consensus 487 fixed exchange rates 754 interventionist supply-side policy 702 Z06_SLOM4772_09_SE_IDX.indd 23 ISLM analysis 666 market-oriented supply-side policies 690, 691 monetary changes and national income 566 monetary effects of changes in goods markets 574 supply-side policies 686 see also inflation and unemployment: new classical school New Economic Policy 22 New Economics Foundation 379 New Electricity Trading Arrangements (NETA) 394 – new growth theory 421 new Keynesians 481, 484, 487, 516, 682 new orthodoxy 477 new realism 260 non-accelerating-inflation rate of unemployment (NAIRU) 483, 604, 615 – 16, 617, 621 non-bank private sector 546 non-discrimination in international trade 728 non-economic discrimination 267 non-excludability 325, 358 non-interest-bearing deposits 794 non-intervention see laissez-faire non-marketed items 412 non-monetary costs and benefits 340 non-price competition 196, 198, 208 non-renewable resources 280, 423 non-risk-based leverage ratio 537 non-rivalry 325 non-wage employment costs 697 normal good 38, 71, 117, 249 normal rate of return 274 normative statement 29 North American Free Trade Association (NAFTA) 732 Northern Rock 524, 530 nudge theory 126, 127 number unemployed (economist’s definition) 432 numerical flexibility 264, 265 Obama administration 344, 365, 632 objective function 113, 152 occupational mobility 251 Office for Budget Responsibility 301 Office of Communications (Ofcom) 393 Office of Fair Trading (OFT) 385, 386, 388 Office for Gas and Electricity Markets (Ofgem) 393, 394, 395 I:23 Office of Water Services (Ofwat) 393 Official List 276 official loans rescheduling 825 Oil Producing and Exporting Countries (OPEC) 202 – 3, 754, 768 oil shocks (1970s) 448, 823 – oligopolistic collusion 198, 201, 204, 224, 337, 383, 396, 732 oligopoly 171, 172, 173, 180, 197 – 209, 225, 241, 257 – 8, 332 aggregate supply 594 barometric firm price leadership 201 barriers to entry 197 buying power of grocery sector in UK 208 competition and collusion 198 concentration ratios for Innocent Drinks Company 199 dominant firm price leadership 200–1 government failure and the case for the market 350 government intervention 330, 334 industry equilibrium under collusive oligopoly 198 – 200 interdependence of firms 198 non-collusive 198, 204 – 7, 224 Oil and Petroleum Exporting Countries (OPEC) cartel 202 – power 737 and the public interest 207 – tacit collusion: price leadership 200–1 union 257 – see also oligopolistic collusion oligopsony 208, 256, 257 open economy 453 open economy and ISLM analysis 772 – balance of payments equilibrium (BP curve) 772 – elasticity of supply of international finance 773 equilibrium 773 fiscal policy under fixed exchange rates 773 – fiscal policy under floating exchange rates 775 fixed exchange rate 772 – free-floating exchange rates 774 – full equilibrium in goods, money and foreign exchange markets 773 marginal propensity to import 773 monetary policy under fixed exchange rates 774 monetary policy under floating exchange rates 775 – open-market operations (OMOs) 539, 643, 644, 646 Operation Twist 647 11/13/14 2:31 PM www.downloadslide.com I:24 INDEX operational standing facilities 539 opportunity cost 11, 12, 15, 108, 139, 140, 315 and choice 10 – 11 constant 712 – 13 increasing 15 informal sector 19 international trade and specialisation 714, 716 of production, increasing 16 of studying 14 optimal currency area 791, 792 optimal position 177 optimum consumption point 103 – 5, 112 – 13, 115 – 16, 118 optimum production point 152 optimum rate of saving 675 optimum tariff 723 opting in versus opting out 127 ordinary share capital 533 Organisation for Economic Cooperation and Development (OECD) 379, 410, 432 – 3, 703 Development Assistance Committee (DAC) 829 Organisation for Economic Cooperation and Development (OECD) Environmental Outlook 355 organisational economies 145 organisational slack 239 Osborne, G 487, 692 Ostrom, E 328 other financial corporations (OFCs) 539, 548, 551, 569 output 132, 149, 152, 157 actual 17, 415, 417 classical analysis 468 – determination see price and output determination economic growth with technological progress 678 financial crisis and new consensus 487 gap 414 – 15 for given cost of production 152 maximising for given total cost 152 natural level 597 potential 17, 414, 415, 417, 419 steady-state 674 see also integrated model of output, inflation and expectations Outright Monetary Transactions (OMTs) 651 outsiders 259, 482, 483 over-confidence/over-optimism 277 overheads 145 – overshooting 762 – 3, 764 Oxfam 829 Z06_SLOM4772_09_SE_IDX.indd 24 Paish, F 636 paradox of aggregates see fallacy of composition paradox of debt (or paradox of deleveraging) 488 paradox of thrift 488, 489 parental leave 263 Pareto criterion 346 Pareto improvement 315, 316, 321 potential 347, 373 Pareto optimality 315, 316, 317, 318, 319, 321 – 2, 323, 331, 391 lack of 327, 329 Pareto, V 315 Paris Club 825, 826, 827 Parsley, D 759 part-time workers 263 participation rate 675 patents 182 pay-as-you-earn scheme (PAYE) 297 payday loans 388 peak-load pricing 215 peg 566 adjustable 750, 765 crawling 751, 795 penal rate 643 pension funds 548 pensioner poverty 311 percentage tax 81 perestroika (economic reconstruction) 22 perfect competition 171, 172 – 80, 184 – 5, 186, 329 assumptions 172 concentration ratios: measuring degree of competition 173 constant industry costs 177 decreasing industry costs: external economies of scale 177 e-commerce and market structure 178 – government intervention 330 incompatibility and substantial economies of scale 177 increasing industry costs: external diseconomies of scale 177 long-run 173 long-run equilibrium of the firm 176 – long-run industry supply curve 176 – loss minimising 175 and monopolistic competition comparison 196 – output 174 – preliminary definition 35 price 174 privatisation and regulation 391 and public interest 177 – 80 rate of profit 173 – 4, 175 short-run 172 short-run equilibrium of the firm 174 – short-run supply curve 175 – see also efficiency under perfect competition; wage determination under perfect competition perfect knowledge 172, 178 – 9, 247 perfect markets 35 perfectly competitive factor market 269 perfectly contestable market 188 personal income tax 297 personal loans 532 Phillips, B 450 Phillips curve 450 – aggregate supply 601 aggregate supply and expectations 610 – 13 breakdown 451, 615 fiscal policy 630 inflation 515 integrated model of output, inflation and expectations 619 Keynesian position on inflation and unemployment 615 – 16 Keynesian revolution 476 long-run 478, 489 original 450 – policy-making environment 659 short-run 613, 617 unemployment 450 – 1, 515 see also expectations-augmented Phillips curve Phillips loops 620 physical capital 268, 273 – 4, 697 physical goods (previously visibles) 453 physical product, average 135 – 6, 137 picketing 258 plant economies of scale 145 plant, machinery and cultivated assets 677 point elasticity 67 – 8, 71 point method 65 police as a public service 326 policy: discretionary 657 and economics 29 family-friendly 263 ineffectiveness proposition 479 objectives, external 742 – objectives, internal 742 – see also policy-making environment 11/13/14 2:31 PM www.downloadslide.com INDEX policy-making environment 656 – 64 Bank of England Rule 663 discretion, case for 657, 659 – 64 inflation targets 658, 662 – interest rate responses and financial crisis (2007 – 8) 660 – political behaviour 657 rules, case for 657 targets, difficulties with 659, 664 Taylor rule 659, 662, 663, 664 time lags with discretionary policy 657 political behaviour 657 political business cycle 608 political left 486, 487 political right 486, 487 pollution policies 359 – 69 Carbon Emissions Trading Scheme (ETS)(EU) 366 – command-and-control systems (laws and regulations) 360 – 1, 363 education 361 emissions charge 360 environmental agenda 364 – environmental (‘green’) taxes and subsidies 360 game theory and international agreements 368 government, reliance on 367 – green taxes 362 – individuals’ attitudes and behaviours 364 – international co-ordination on climate change: Kyoto Protocol 364 – market-based policies 359 – 60 private property rights 359 social efficiency approach 360 tradable permits 362 – user charges 360 voluntary agreements 361 pooling risks (for an insurance company) 123 population: growth 134, 819 per capita measures 409 – 10 Porter, M 718 portfolio balance 567 portfolio investment 455 positive statement 29 positive sum game 25 post-Keynesians 487, 488 Postal Services Act (2011) 389 potential growth 17, 414 potential output 17, 414, 415, 417, 419 poverty see inequality and poverty Z06_SLOM4772_09_SE_IDX.indd 25 Poverty Reduction Strategy Paper (PRSP) 827 poverty trap 308, 309, 691 Pratten, C.F 156 precautionary effect 503 precautionary motive 553 predatory pricing 190 – 1, 217, 387 prediction (models) 27 – preference shares 533 preferential trading 729 – 33 arrangements 729 – 30 Asia-Pacific Economic Co-operation (APEC) forum 732 – common markets 432, 729 – 30 customs unions 729, 731 – free-trade areas 729 North American Free Trade Association (NAFTA) 732 in practice 732 – trade creation 730 trade diversion 730 – prejudice 263 present value approach to appraising 272 – price: of and/or return on substitutes 52 – benchmark 201 ceiling 55 changes 467 classical analysis 469 – 70 control 55 – and demand, relationship between 35 – effect of changes in 115 – 16 equals marginal cost 177 – expectations and speculation 75 – fiscal policy 636 flexibility 243 floor 55 and income elasticities of demand in UK for foodstuffs 87 inelasticity of demand 482 leadership 396 maximum 55 mechanism 21, 24 minimum 55 reform 817 rigidity, nominal 481 – stability 207 and supply 52 taker 35, 159, 172 and wages flexibility 465 – price discrimination 214 – 19, 387 advantages to firm 216 cinema tickets 218 competition 217 conditions necessary for operation of 214 – 16 I:25 distribution 217 first-degree 214, 216 and monopoly 186 peak-load pricing 215 profit-maximising prices and output 216 – 17 profits 217 and the public interest 217 second-degree 214 third-degree 214, 216 – 17 on trains (London) 215 price elasticity of demand 61, 69, 160, 218 average (or midpoint) formula 66 and consumer expenditure 63 – determinants 62 – formula 61 measurement 61 price elasticity of supply 69 – 71 formula 70 price and output determination 45 – 54 demand and supply curves, identifying position of 49 – 54 equilibrium price and output 45 – house prices (UK) 50 – incentives 54 incentives in markets 49 markets equate demand and supply 47 movement to a new equilibrium 47 – stock market prices 52 – price-cap regulation 393 price-consumption curve 116 price-consumption line 116 price-making firms: straight-line demand ‘curve’ 161 price-taking firms 161 pricing 240 – cost-based 240 – flexible 609 irrational consumers and profit increases 244 predatory 190 – 1, 217, 387 price-setting by companies 242 – strategies 482 primary labour market 264 primary market in capital 275 principal-agent problem 224, 261, 330 Priority Schools Building Programme (PSBP) 693 prisoners’ dilemma 210, 211, 368, 727, 785 private efficiency 315 Private Finance (PF2) 692 – Private Finance Initiative (PFI) 694 private property rights, extension of 359 11/13/14 2:31 PM www.downloadslide.com I:26 INDEX privatisation and regulation 328, 389 – 96 accountability to shareholders 390 advantages of privatisation 389 – 90 disadvantages of privatisation 390 – electricity industry 394 – externalities and inequalities 391 – fairness 392 first-best situation 391 fiscal policy 627 government interference, reduced 390 greater competition 390, 396 market forces 389 – 90 market-oriented supply-side policies 694 nationalisation 389 natural monopolies 390 – planning and co-ordination of industry 391 regulation 392 – assessment 393 – identification of short-run optimum price and output 391 – identifying long-run optimum price and output 392 second best theory 391 tax cuts, financing 390 utilities 337 pro-cyclical changes 483 problem of the second best 333 procurement policies 720 producer surplus 329 producers’ share of a tax on a good 83 product: development 196 differentiation 182, 194, 208 method of GDP calculation 409, 425 – production costs 43, 700 function 135, 137, 415 Cobb-Douglas 148, 149 -line processes 146 mass production 146 multi-stage 145 point, optimum 152 possibility curve 13 – 17, 321 – 2, 712, 714, 716, 717 quotas 93 see also factors of production; longrun theory of production productive capacity 231 productive efficiency 12, 147 productivity: deal 257 gap 700 Z06_SLOM4772_09_SE_IDX.indd 26 of labour 253 of resources, increase in 420 profit 132 in Cournot model 205 – money supply 545 normal 165, 175, 254, 274 rate 173 supernormal 274 see also capital and profit profit maximisation 162 – 7, 170 – 92, 193 – 219, 252, 267 alternative market structures 171 – average curves 164 contestable markets theory 188 – 91 definition of profit 164 – difficulties 222 driving down costs 167 driving up profits 167 driving up revenues 167 employment of land and capital 269 finding where MR equals MC 165 logistics 167 long-run 164, 166 long-run shut-down point 167 loss minimising 166 marginal curves 163 – maximising total profit equation 165 maximum profit output calculation 165 maximum profit using totals curves 163 monopolistic competition 194 – price and mark-up 241 rule 163 short-run 166 short-run: average and marginal curves 163 – short-run: total curves 163 short-run shut-down point 167 stock of capital 273 theory 261 total revenue, total cost and total profit 163 whether or not to produce at all 166 – see also game theory; monopoly; oligopoly; perfect competition; price discrimination profit satisficing 223, 229 profitability 532 of alternative products (substitutes in supply) 44 of goods in joint supply 44 and liquidity 532 – progressive tax 300 property rights, changes in 336 proportional tax 300 proportionate or percentage measures 62 protection, effective rate of 812 prudential control 540 Prudential Regulation Authority 540 psychological factors 277, 564 public finances and balance of trade 744 public goods 325 – public interest: and alternative maximising theories 235 – competition policy 382 and contestable markets theory 189 and monopolistic competition 196 – and oligopoly 207 – and perfect competition 177 – 80 and price discrimination 217 and satisficing 239 see also markets, efficiency and public interest public limited company 222 – public works: classical Treasury view 471 – public-sector 627 – deficits 628, 641 deficits and surpluses and government’s fiscal stance 628 – 30 public-sector net borrowing (PSNB) 628, 744 public-sector net cash requirement (PSNCR) 549, 573, 628, 641, 643 public-sector net debt 628, 639 purchasing-power parity (PPP) 771 exchange rate 410 free-floating exchange rates 757, 758 – GDP figures 411 theory 757 purchasing-power standard (PPS) GDP 410 ‘Purity’ EC investigation 384 quantiles 286 quantitative controls 794 quantitative easing 452, 489, 551, 571, 655 Bank of England 539 fiscal policy 636 monetary policy 644, 654, 655 QE1 647 QE2 647 QE3 647 quantity changes (elasticity) 62 quantity demanded 36 change in 38 11/13/14 2:31 PM www.downloadslide.com INDEX quantity supplied, change in 44 quantity theory of money 469 – 70, 471 – 2, 474, 477, 489, 561 quintiles 286 quotas 202 – 3, 720, 728, 767 and exchange rates 460 production 93 set by a cartel 199 random shocks 464, 520, 635 random walk 277 rate of return approach 272, 273 rational choices 11 – 12, 100, 114, 129 rational consumer 101 behaviour 104 rational decision making 11, 12, 105 rational economic behaviour 315 rational expectations 479, 609 – 10, 611 – 12, 617 rational forward-looking optimising economic agents 484 – rational producer behaviour 133 rationalisation 145, 698 rationality 125 bounded 126, 128 rationing 56 reaction function (or curve) 205 Reagan administration 349, 687, 688, 689 Reaganomics 689 real balance effect 442 real business cycle theories 479 – 80, 482, 613 – 14 real gross domestic product (GDP) 409, 417 business cycle (Keynesian analysis) 519 or GDP at constant prices 409 globalisation and instability 779 market imperfections 482, 483 new classical school 480 in selected countries 787 real income 113 real and nominal values, distinction between 411 real-wage rigidity 482 real-wage unemployment 437 – realignments 795 recession 9, 416, 417, 418, 520 financial crisis and new consensus 489, 490 house prices 50 hysteresis 483 Keynesian position on inflation and unemployment 615 – 16 stock market prices 53 unemployment 431, 434 reciprocity in international trade 728 Z06_SLOM4772_09_SE_IDX.indd 27 redemption price 541 rediscounting bills of exchange 541 redistribution and inflation 446 redistributive effects in pollution policies 363 reference value (ECB) 648 refinancing operations 650 – refinancing rate 643 reflation/reflationary policies 476, 616, 766 regional multiplier effects 699, 702, 737 regional policy 699, 702, 734 regional unemployment 440 regression analysis 39 regressive tax 300 regulatory capture 393 relative price 26, 500 rent: controls 57 see also land and rent replacement costs 139 repo markets 541 repo rate (discount rate) 529, 649 representative agents 480 with rational expectations (RARE) 488 resale (or retail) price maintenance 386 reserve accounts, interest-bearing 543 reserve averaging 539 reserve requirements 646 reserves 455, 460, 529, 532, 533 resource allocation 20 restrictive practices 383, 385 – retail banking 526 retail deposits 532 and cash in M4 (previously M2) 544 returns to scale 149 constant 144, 148, 149, 152 decreasing 144, 148, 149, 152 increasing 144, 148, 149, 152 revaluation 750, 767 revenue 158 – 62 average revenue (AR) 159, 160, 161, 162 curves, shifts in 162 curves when price varies with output 160 – for firm facing downward-sloping demand curve 160 marginal revenue (MR) 159, 160 – maximisation 218 price elasticity of demand 161 price-making firms 161 price-taking firm 159, 160, 161 total revenue (TR) 158, 159 – 60, 161 – I:27 Revenue Incentives Innovation Outputs (RIIO) 393 reverse repos 530 reverse shocks 614 Ricardo, D 107 risk 77 – 80, 225 – aversion 122, 211, 275 factors 533 independent 123 loving 122, 211 neutral 121 and sub-prime market 534 transformation 526 and uncertainty 80, 343 – -weighted assets 533 see also demand under conditions of risk and uncertainty rivalry 326, 358 Roskill Commission 342 RPI inflation 605 – RPI minus X formula 393, 394 run on the bank 524 run on the currency 455 Russia 22 – Sadler, L 375 sale and repurchase agreements (repos) 529 sales revenue maximisation 229 – 30, 235 Sargent, T 610 satisficing 238 – savings 289 – 90, 469, 489 accounts 528 flows 403 net 406, 499 rate increase 674 – 5, 678 Say, J.-B 469 Say’s law 469, 470, 474 scarcity – 8, 9, 11, 16, 358 Schumacher, E.F 379 Schumacher, U 815 screening (insurance) 124 seasonal unemployment 440, 513 second-best solution 333, 334, 342 second-best theory 391 second-degree price discrimination 214 secondary action 259 secondary market in capital 276 secondary marketing 533 – sector accounts 403 – sector income accounts 408 Securities and Exchange Commission 78 Securities Market Programme (SMP) 651, 791 securitisation 226 – 7, 530, 533 – 11/13/14 2:31 PM www.downloadslide.com I:28 INDEX self-employment 289, 301 self-fulfilling speculation 75 self-interested behaviour 129, 319 semi-strong form of efficiency 276 – senile industry argument 721 sensitivity analysis 343 sentiment and spending 504 – Serious Fraud Office 385 set-aside 93 share/shares 275 capital 529 new issue 231 prices 53, 78 yield 277 shirking 261, 262 shocks: exogenous 657 external 759 internal 757 – random 464, 520, 635 reverse 614 stochastic 485 supply-side 448, 480 technology 480, 613 short selling (or shorting) 78 short-run 133 – 5, 152, 153 average cost curve 155 – and long-run analysis, merging of 484 shut-down point 166 supply of capital services 270 – supply curve 175 – under perfect competition 172 – short-run theory of production 133 – averages and marginals, relationship between 138 diminishing returns 134, 135, 137 population growth and starvation 134 production function: average physical product 136 – 7, 138 production function: marginal physical product 137, 138 production function: total physical product 135 – 6, 138 short- and long-run changes 133 – short-termism 275, 276, 393, 696 shut-down point, short-run 166 sight accounts (checking accounts) 646 sight deposits 528 Single European Act (1987) 350, 695, 735 single European market 251 Single Market Directive 737 size distribution of income 285 Skills Funding Agency 701 slowdown 483 Z06_SLOM4772_09_SE_IDX.indd 28 Smith, A 24 – 5, 47, 107, 225 Smith, I.D 309 snowballing effect 239 Snowdon, P 471 social benefit 324 social charter 734 social cost 323, 812 social effects of long-term economic growth 423 social efficiency 315, 320, 331 between consumers 321 between producers 321 economics of the environment 355, 358 in exchange 321 – intermediate analysis 320 in the market 317 – 18 Pareto optimality 315 pollution policies 360, 361 road usage 371 – tax rates in pollution policies 362 through the market 316 – 18 under perfect competition 321 – social goals 331 social good 319 social indifference curves 321 – 2, 716 social mobility 310 Social Mobility and Childhood Poverty Commission 310 social objectives 26 social policy 734 social rate of discount 346 social security benefits and pensions 289 – 90 social-impact standards 361 socialism 348 – socially optimum level of road space (long run) 373 soft buffers 795 soft paternalism 127 Solow (neoclassical) growth model 673 – Solow, R 673 sovereign debt crisis 487 Spahn, P.B 796 special purpose vehicles (SPVs) 534 – 6, 548, 569 specialisation 145, 707 – 9, 714, 814 specific tax 80, 299 speculation 51, 75 – 7, 653 – 4, 756 balance of payments and exchange rates 767 destabilising 76 – 7, 128, 570, 760 – free-floating exchange rates 672 – 3, 760 – 1, 764 house prices 51 self-fulfilling 75 stabilising 76, 77 speculative or assets motive 553 speculative demand and the exchange rate 555 speculative financial flows 768 – speculative (or assets) demand for money 554 – speculators 75, 77, 79 Spengler, J 182 spot price 79 spread 540 stabilisers, automatic 641 stabilising speculation 76, 77 Stability and Growth Pact (SGP) 791 – stagflation 476, 477, 605, 615 stakeholders (in a company) 238 Stalin, J 22 Stamp out Poverty 796 standardised unemployment rate 432 – standing facilities 644 state of the economy: fiscal stance 628 – steady-state growth path 678 steady-state level of national income 674 steady-state output 674 sterilisation 651, 748 Stern Report 356 – Stern, Sir N 356 stickiness in wages 437, 438, 439, 473, 481 – stimulus package 632 stochastic shocks 485 stock market 52 – 3, 275 – stocks 426 appreciation 426, 427 and flows 271 fluctuations 518 – 19 holding 80 stop-go policies 476, 767 strategic alliance 233 – strategic trade theory 721 strategy, structure and rivalry of firms in international trade 718 strong efficiency (of share markets) 277 structural balance 629 – 30 structural deficit (or surplus) 629 structural operations 651 structural policies 91 structural problems within developing countries 817 – 23 agriculture, neglect of 817 – 18 BRICS 822 capital-intensity bias 819 devaluation 817 education and advice 817 external influences 820 – financial provision 817 11/13/14 2:31 PM www.downloadslide.com INDEX structural problems within developing countries (continued) government support for rural infrastructure projects 817 land reform 817 new technologies and practices 817 population growth, rapid 819 price reform 817 rural co-operatives 817 – 18 technology, inappropriate 818 – 19 unemployment 819 – 22 structural reform in developing countries 825 – structural unemployment 440, 451, 469, 513, 515, 615 sub-prime debt 536 sub-prime housing crisis (USA) 226 – 7, 780 – sub-prime loans (USA) 51 sub-prime market and risk 534 subcontracting 233 subordinated debt 533 subsidy 333 – 6, 725 employment 725 environmental 360, 362 production 725 on products 426, 427 subsistence level 421 subsistence production 20 substitute goods 37, 62, 119 substitutes: in supply 44 traffic congestion economics 371 substitution effect 35, 304, 308 aggregate demand curve 442 inferior good 117 – 18 inter-temporal 442 international 442, 446 market-oriented supply-side policies 689 normal good 117 of a price change 116 of a rise in wage rates 249 of a tax rise 303 see also diminishing marginal rate of substitution sunk costs 128, 189 Sunstein, C 127 supernormal profits 166, 173, 175, 176, 182 – 3, 184, 188 monopolistic competition 194 wage determination under perfect competition 254 supply 8, 42 – 5, 132 – 67 actual of capital 273 – of capital services 270 – change in 21 – 2, 44, 48 Z06_SLOM4772_09_SE_IDX.indd 29 costs in the long run 154 – curve 42 – 3, 44, 132 elasticity 61 identifying position of 49 – 54 price and output determination 46 – 7, 48 declining farm incomes 87 – determinants 43 – elasticity 82, 301 – 2, 773 equation 45 of finance 273 – hospital treatment provision (providing goods and services free at point of delivery) 84 – house prices 50 inelastic 82 of money curve: endogenous money supply 552 potential and price 52 profit and the aims of a firm 133 profit maximisation 162 – response of to increase in demand 74 revenue 158 – 62 schedule 42 shocks and cost-push inflation 600 shocks (single shifts in aggregate supply curve) 447 short-term price fluctuations 87 stock market prices 53 see also costs in the short run; longrun theory of production; money supply; short-run theory of production supply-side economics 466 supply-side policies 9, 452, 684 – 703, 685 and demand-side policies, link between 687 and economic growth 685 exchange rates 460 financial crisis and new consensus 489 inflation 685 Keynesian approach 686 – and macroeconomy 685 new classical approach 686 ‘Third Way’ policies 687 unemployment 685, 703 see also interventionist supply-side policies; market-oriented supply-side policies supply-side shocks 448, 480 surplus on the current budget 628 surprise models 613 sustainability 355, 726 Svensson, L 662 Sweezy, P 206 I:29 tacit collusion 199, 200 – 1, 213 takeover bid 206 takeover constraint 231 takeovers 182, 199 targets, difficulties with 659, 664 targets and instruments principle 651 tariffs 182, 720, 723 – ad valorem 720 binding 728 carbon 721 escalation 810 and exchange rates 460 external 733 or import levies 90 industrial 727 internal 733 optimum 723, 724 protection 726 rates 812 trade restrictions 726 tastes 37, 180, 371, 498, 501, 808 tax 333 – balance sheets 531 – carbon 363 classical macroeconomics 471 consumers’ share of a tax on a good 83 and consumption 497 cuts 688 – 90 environmental 360, 362 export 724 financial transactions tax (FTT) 794, 797 green 360, 362 – harmonisation 734 incidence of 81 Keynesian revolution 475 marginal tax propensity 499 multiplier 631 net 406, 499 – 500 percentage 81 producers’ share of a tax on a good 83 on products 426, 427 tobacco 82 – Tobin 794, 796 – windfall 334 see also indirect taxes; taxes, benefits and redistribution of income taxes, benefits and redistribution of income 296 – 312, 422 ad valorem tax 81, 299 allowance (tax) 297 average rates of income tax 298 balance of taxation 299 – 300 basic rate of tax 297 basic tax rate cut 304 – benefit principle 296 11/13/14 2:31 PM www.downloadslide.com I:30 INDEX taxes, benefits and redistribution of income (continued ) benefits 306 – capital gains tax 298 cheapness of collection 296 convenience to government 297 convenience to taxpayer 297 corporate tax 298, 300 council tax 299 credits (tax) 310 customs duties (tariffs) 299 cuts and incentives 304 – different types of people 304 different types of tax change 305 – difficulty of evasion 297 direct taxes 297 – 9, 427 economic costs of redistribution 302 – employers’ social security contributions 298, 300 evasion and avoidance 297, 301 evidence 306 excise duties 299 general expenditure taxes 299 goods and services taxes 301 higher rate of tax, cut in 305 horizontal equity 296 how to help the very poor 301 incentives 303 – income redistribution 296, 300 income tax 297, 298, 301, 302, 304, 308 indirect tax 299, 302 individuals’ social security contributions 298 Laffer curve 303 legislation 296 lump-sum tax 300 marginal income tax 298 marginal tax-plus-lost-benefit rate (marginal deduction rate) 308 – minimal disincentive effects 297 negative income tax 308 no income tax 304 non-distortion 297 pay-as-you-earn (PAYE) scheme 301 payroll taxes 300 personal allowances 301 poll taxes (community charge) 299 problems with using taxes to redistribute incomes 300 – progressive taxes 300, 301, 304 proportional tax 300 purchase taxes 299 raising basic rate of tax 305 – raising higher rates of tax 305 rates of tax 301 reducing tax allowances 306 Z06_SLOM4772_09_SE_IDX.indd 30 regressive tax 300 requirements of a good tax system 296 – specific tax 80, 299 structural policies 296 subsidies 296 tax/benefit system and disincentives: poverty trap 308 threshold rise 305 types of tax 297 – 300 undesired incidence of tax 301 – value added tax 297, 299 vertical equity 296 wealth, taxes on 298 – Taylor, J 659 Taylor rule 578, 659, 661, 662, 663, 664 team work/collective effort 265 technical inefficiency see X inefficiency technological progress/improvement 208, 421, 504, 731, 809 technological unemployment 440, 615 technology: inappropriate 818 – 19 and market power position 178 shocks 480, 613 state of 154 technology-based standards 361 terms of trade 714 – 16, 731 deterioration 809 – 10 Thaler, R 127 Thatcher government 349, 438, 478, 480 market-oriented supply-side policies 687, 688, 691, 692, 694 ‘Third Way’ policies 687, 692 – 3, 702 third-degree price discrimination 214, 216 – 17 Thurow, L 722 tie-in sales 387 Tier capital 532, 533, 537 Tier capital 533, 537 time deposits 528, 646 time dimension 74 – 80 dealing in futures markets 79 price expectations and speculation 75 – short selling 78 short-run and long-run adjustment 74 – uncertainty and risk 77 – 80 time lags 62 – 3, 70, 520, 635 – 6, 657 tit-for-tat game 212 tobacco taxes 82 – Tobin, J 794, 796 Tobin tax 794, 796 – total consumer expenditure on a product 63 total consumer surplus 104 total cost 140 – 1, 152 curve 162 of production 132 total currency flow balance 742 total factor productivity 424, 680 total physical product 135 total (private) surplus 317 total producer surplus 316 total product 135 – total quality management (TQM) 265 total revenue 158 curve 162 (per period of time) 63 total sales revenue 132 total social surplus 318 total utility 101 – of income 123 total volume of national output 441 tradable permits 362 – trade: creation 730, 735 – cycle see business cycle diversion 730 – 1, 737 in goods account 453 see also international trade; trade restrictions trade restrictions 182, 719 – 29 administrative barriers 720 arguments in favour of 720 – bureaucracy 726 corruption 726 – cost of protection 723 country with monopoly supply of export 723 country with monopsony demand for an export 723 dumping 720, 725 economic arguments having some general validity 720 – economic arguments having validity for specific groups or countries 722 – embargoes 720 environmental issues and free trade 720 exchange controls 720 import licensing 720 imports should be reduced since they lower the standard of living 725 improvement in balance of payments 723 infant industry argument 720 – market power 722 – method 720 11/13/14 2:31 PM www.downloadslide.com INDEX trade restrictions (continued) non-economic arguments 723 optimum tariff or export tax 724 prevention of dumping and other unfair trade practices 721 prevention of establishment of foreign-based monopoly 721 prevention of importation of harmful goods 721 problems with protection 723 – procurement policies 720 protection of declining industries 723 protection may allow firms to remain inefficient 726 protection needed from cheap foreign labour 725 protection reduces unemployment 725 protection as ‘second best’ 725 quotas 720 reduction of influence of trade on consumer tastes 721 reduction of reliance on goods with little dynamic potential 721 retaliation 726 senile industry argument 721 spread of risks of fluctuating markets 721 strategic trade theory 722 subsidy 725 taking account of externalities 721 tariffs 720, 723 – 4, 726 why buy goods from abroad and deny jobs to workers in this country? 725 world multiplier effects 725 – World Trade Organization 726 – trade unions 259 trade-offs 331 traditional theory of the firm 133 traffic congestion economics 369 – 73 actual and optimum road usage 372 car ownership increase in European countries 370 complements, price of 371 congestion costs 371 – cost-benefit analysis 373 demand for road space (by car users) 369 – 71 environmental costs 372 existing system of road space allocation 369 – 71 income 370 long-run supply of road space 371 marginal social benefit of road usage 371 marginal social cost of road usage 371 – Z06_SLOM4772_09_SE_IDX.indd 31 motoring costs as percentage of household expenditure 370 passenger transport in UK 369 price 370 road space, supply of 371 short-run supply of road space 371 socially efficient level of road usage (short run) 371 – substitutes, price of 371 tastes/utility 371 time taken to travel between points along a given road 372 tragedy of the commons 327 training and education 267 – 8, 699, 700 – Training and Enterprise Councils (TECs) 700 transactions motive 553 transactions plus precautionary demand for money 553 – transfer payments 406, 427 transfers 627 transport costs 146, 173, 714 transposition (or implementation) deficit 737, 738 Treasury 540 bills 529, 532, 541 market-oriented supply-side policies 693 view of balanced budgets (classical) 476 view on public works 471 – view on unemployment (classical) 471 Treaty of Amsterdam 794 Treaty of the Functioning of the European Union 383, 384, 385, 387 Treaty of Rome 91, 733 Troubled Asset Relief Program (TARP) 647 trust 368 Turner, A 127, 797 ‘20/20/20’ package 366 two factor case: marginal product approach 147 – uncertainty 77 – 80, 78, 231, 446 see also demand under conditions of risk and uncertainty underconsumption 489 underemployment 819 ‘underground’ markets/economy 22, 56, 57, 412 unemployment 9, 10, 401 – 2, 431 – 41 age group differences 435 average duration 439 average unemployment rates 432 I:31 business cycle, phase of 434 by duration 433 circular flow of income 408 claimant 432, 434 classical macroeconomics 471 classical Treasury view 471 composition 435 – costs 436 definition 432 demand, change in pattern of 440 demand-deficient or cyclical 438 – 9, 447, 513, 515, 685 disequilibrium 436, 437 – 9, 465 – 6, 467, 473, 690 – disguised 819 duration 433 – equilibrium (or natural) unemployment 436, 439 – 40, 478, 630, 690 ethnic group differences 435 – financial crisis and new consensus 489 flows into and out of 434 frictional (search) 439 – 40 gender differences 435 geographical differences 435 hysteresis 483 and inflation 450 – interventionist approach 440 Keynesian revolution 476 and the labour market 436 – 7, 439 market-oriented approach 440 mass 464, 472, 473 monetarism 478 natural rate 604 number employed (size of stock of unemployment) 433 official measures 432 – pool 433 – rate 432 rate of inflow and outflow from stock of unemployment 433 – rate, standardised 432 – real-wage 437 – regional 440 seasonal 440, 513 standardised unemployment rates 431, 432 – 3, 435 structural 440, 451, 469, 513, 515, 615 structural problems within developing countries 819 – 22 supply-side policies 685, 703 technological 440, 615 trap 309 voluntary 606 and wage cuts 474 see also non-accelerating-inflation rate of unemployment 11/13/14 2:31 PM www.downloadslide.com I:32 INDEX unemployment and inflation 593 – 623 macroeconomic thinking post-crisis 622 – modern Keynesian position 615 – 18 output, inflation and expectations: integrated model 618 – 21 see also aggregate supply; expectations-augmented Phillips curve; inflation and unemployment: new classical school unemployment and inflation (Keynesian analysis) 513 – 16 AD/AS diagram and 45° line diagram, relationship between 515 at the same time 514 – 15 deflationary (recessionary) gap 513 full-employment national income 513 inflationary gap 513 – 14 union monopoly or oligopoly 257 – unit elasticity: of demand 62, 64 – of supply 70 unit trusts 548 United Nations 95, 786, 829 Conference on Environment and Development (UNCED) 827 Development Programme (UNDP) 804 United States: central bank and monetary policy 646 – Department of Justice 190 Department of Transportation 343 and Kyoto Protocol 365 M3 544 Securities and Exchange Commission 234 trade imbalance 782 – see also Federal Reserve universal banks 527 universal benefits 306 Universal Credit 309, 310, 702 – University for Industry 701 urban policy 699, 702 urban transport policies 373 – area charges 376 area licences 377 car access restriction 374, 375 congestion may not be solved 374 direct provision (supply-side solutions) 373 – electronic road pricing (ERP) 377 environmental impact of new roads 374 equity objective 373 Z06_SLOM4772_09_SE_IDX.indd 32 existing taxes, extending 374 – government or local authority provision of public transport 374 greener vehicle discount 376 London Congestion Charge 376 market signals, changing 374 – new taxes, introduction of 375 parking restrictions 374 regulation and legislation 374 road pricing 375 – road solution 373 – subsidising alternative means of transport 377 – variable electronic road pricing 376 – variable tolls 376 urban wages above market-clearing level 811 – 12 user charges 360 util 101 utility function (Cobb-Douglas) 113 value added 425 domestic 812 gross 425, 426, 427 value added tax (VAT) 297, 299 value, expected 340 value-in-exchange 107 value-in-use 107 variable costs 139, 140, 175 variable factor 133 variable minimum reserve ratios 645 velocity of circulation 406, 470, 567 – 71 causality, direction of 571 long-run stability 567, 570 – money balances in different sectors 568 – money and spending, growth in 568 short-run variability 567, 571 stability 570 – Venezuela 826 vent for surplus 807 – vertical de-mergers 237 vertical equity 296 vertical merger 232 vertical price-fixing agreements 385 – vertical restraints 387 voluntary agreements 361 voluntary unemployment 606 wage cuts 474 wage determination in imperfect markets 256 – 68 behaviour at work and employee motivation 266 collective bargaining 258 – discrimination 263 – efficiency wage hypothesis 259 – 63 equal pay for equal work 262 – firms and labour with market power (bilateral monopoly) 258 firms with market power in employing labour (monopsony) 256 – flexible labour markets and flexible firm 264 – labour market imperfections 263 labour with market power (union monopoly or oligopoly) 257 – labour movement/trade unionism in the UK 26 labour turnover, reduced 261 marginal productivity theory 261 morale 262 ‘shirking’, reduced 261 wage determination under perfect competition 247 – 55 causes of inequality 255 demand for labour: marginal productivity theory 252 – derivation of firm’s demand curve for labour 253 derivation of industry demand curve for labour 253 – elasticity of demand for labour 254 elasticity of market supply of labour 250 – equality and inequality 254 – immigration and UK labour market 251 indifference curve analysis to derive individuals’ supply curve of labour 250 labour as a factor of production 248 labour supply 248 – 51 low-paid to high-paid jobs 255 marginal cost of labour (MCL) 252 marginal product of labour (MPL) 253 marginal revenue product of labour (MRPL) 252, 253 market supply of a given type of labour 249 – 50 mythical world of perfect wage equality 254 – perfect labour markets 247 profit-maximising approach 252 – supply of hours by an individual worker 248 – supply of labour to an individual employer 249 wages and profits under perfect competition 254 11/13/14 2:31 PM www.downloadslide.com INDEX wage rates 253, 443 above market-clearing level 818 wage setters 256 wage taker 247, 249 wages: flexible 609 and profits under perfect competition 254 rent and interest 271 and salaries 289 – 90 stickiness 437, 438, 439, 473, 481 – Walras, L 107, 348 War on Want 794, 796 waste elimination 265 weak efficiency (of share markets) 276 wealth: distribution of 285, 289, 292 – national 524 stock market prices 53 Webb, S 311 Wei, S.-J 759 welfare reduction 691 – Z06_SLOM4772_09_SE_IDX.indd 33 Welfare to Work Programme 702 White Knight strategy 232 wholesale banking 526 – wholesale deposits and loans 526 wholesale funding 530 – Wilde, O Willetts, D 311 Williamson, J 794 – Williamson, O.E 228 – win-win situation 25 windfall tax 334 withdrawals 406 – 7, 499 – 501 function, total 501 imports 500 – and injections, relationship between 407 Keynesian revolution 474 – or leakages 406 – marginal propensity to withdraw 501 monetary changes and national income 561 MPC 500 I:33 net saving 499 net taxes 499 – 500 shift in 509 – 10 Wolf, A 701 Wolf report 701 workforce, increase in 675 – Working Families Tax Credit 309 Working Tax Credit (WTC) 309 working to rule 258 World Bank 796, 812, 825, 827 Logistic Performance Index 822 world multiplier effects 725 – World Trade Organisation 74, 727 – 8, 779 Doha Development Agenda 92, 726 – 7, 728, 809, 816 X inefficiency 186, 225 yield on a share 277 zero price 16 zero-hours contracts 260 11/13/14 2:31 PM ... USA EU12a 2. 9 2. 4 2. 7 2. 8 1.9 1.4 4.3 3 .2 3.1 3 .2 1.8 2. 4 5.8 3.8 2. 3 2. 2 1.3 0.9 5.5 3.7 2. 9 2. 5 1.8 1.9 1.3 1.7 2. 5 3.0 4.7 4.5 2. 2 4.5 9.9 8 .2 5.4 7.7 4.1 6.1 7.3 5.8 5.5 8.1 2. 5 4.0 9.3 10.5... 9.1 2. 5 1 .2 −0.3 0.6 3.8 12. 6 7.0 3.3 1.8 2. 9 2. 4 7.1 5.6 3.0 2. 6 1.9 3.7 9.5 6.5 2. 9 2. 1 1.3 Germany Japan 4.4 3.1 1.9 2. 2 0.9 1.9 10.4 5 .2 4.4 1.5 0.6 1.7 0.9 2. 3 6.9 7.9 9.0 5.8 3 .2 4.9 2. 9 2. 4... of nominal GDP 20 05 20 06 20 07 20 10 20 11 20 08 Financial liabilities, £bn 124 7.6 1399.5 1508.5 1536 .2 GDP, £bn 127 6.7 1349.5 1 427 .9 14 62. 1 Financial liabilities as % of GDP 20 09 20 12 Financial liabilities,