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REVIEW OF HWK

BoP Q&A

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Balance of Payment Questions.

1. What is meant by (2 marks each = 6 in total)

A trade gap?

A current account deficit?

A current account surplus?

2. Explain why an economic boom may result in a current accountdeficit. (3 marks)

3. Explain why a recession may result in an improvement in thecurrent account position. (3 marks)

4. To what extent might a current account deficit have an effect on

Employment?

Inflation?

Growth?

4 marks each = 12 marks Total = 24 marks

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Balance of Payment Questions.

1. What is meant by (2 marks each = 6 in total)

A trade gap?

the difference in value over a period

of time of a country's imports and

exports

A current account deficit?

Where M>X

A current account surplus?

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Explain why an economic boom may result

in a current account deficit. (3 marks)

Boom = lots of employment, consumer confidence, businessprofits.

Confidence = C + I which can often lead to greater need for goodsbeyond domestic production, therefore greater iMports!

Also draw a boom macro diagram what happens to prices?

So domestic goods more expensive & so less competitive, thereforeless eXports!

Also exchange rates gets stronger so SPICED!

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Explain why a recession may result in an

improvement in the current account position.

(3 marks) Draw a recession diagram

Increasing unemployment

Lower prices

Fall in confidence (both consumer and producer)

So more eXports with weaker exchange rates and lowerprices makes us more competitive

There might be lower iMports as they become moreexpensive

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To what extent might a current account deficit have an

effect on employment? Inflation? Growth?

Where M > X

Fall in employment but why? Rise in inflation but why?

Fall in growth but why?

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Inflation & Deflation

Recap & move forward

http://news.bbc.co.uk/1/hi/uk/8010442.stm

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Recap

What was the more recent FIVE causes

of UKs rise in inflation last month?

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Recap

What was the more recent FIVE causes

of UKs rise in inflation last month?

F= Fuel

I = Imports create higher costs

V = VAT

E= exchange rates

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Recap

In theory what are the 2 different types

of inflation?

Demand pull inflation

Cost push inflation

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Recap

Can you draw me a cost push inflation

diagram (show SR & LR AS)

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Draw an Classical AD/AS

diagramPrice Level

Real NationalOutput

Y1

LRAS

0

AD

SRAS1

SRAS2

Y2

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Deflation

Is it good or bad?

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Deflation

Deflation is a sustained fall in the general

price level

A sustained period of negative inflation

The internal value of money rises

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Deflation for some productsAnnual percentage change in the consumer price index for selected items

Price deflation in many markets for UK consumers

Source: Reuters EcoWin

Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct

01 02 03 04 05

1996=100

-16.0

-14.0

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

Audio-visual and photo equipment

Clothing and Footwear

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Annual Percentage Change

Consumer Price Inflation for Goods and Services

All items (CPI), Chg Y/YAll goods, Index [ar 12 months]

All services, Index [ar 12 months]

Source: Reuters EcoWin

00 01 02 03 04 05 06

Percent

-3

-2

-1

0

1

2

3

4

5

6

Goods and Services Together

Inflation in Services

Inflation in Goods

Describe the changes

in the data provided.

What effects do you

think this had on the

economy?

Whats the

trend?

Whats the

start &

end points?

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The diagrams

demand side cause of deflation

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Demand side causes of Deflation

A Large (adverse) Fall in AD

Exogenous shocks to the economy

A global recession leading to a fall in exports

and investment A rise in the exchange rate (leading to lower exports and

cheaper imports)

Declines in domestic and international asset prices

Deliberate attempts by macroeconomic policy toreduce AD through tightening of fiscal and/ormonetary policy

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Next lesson..

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Multi choice

Dont get excited there is NO

multi choice for paper 2

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Real incomes rise whenever

A nominal incomes rise.

B the price level rises by more thannominal incomes.

C nominal incomes rise by more than the

price level. D the rate of inflation slows down.

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Inflation article

Read

use highlighters to select key positive &negative issues

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Whats so BAD about inflation?

RPI is an aggregate figure what doesthis mean?

Why are interest rates on mortgages such

an important monetary tool to controlinflation?

What is the difference between nominal

and real prices? The article identifies 4 problems ofinflation. What are they?

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LR Cost push deflation

Price Level

Real NationalOutput

Y1

LRAS

0

AD

SRAS1

Y2

LRAS

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Supply side causes of deflation

An Increase in Long Run Aggregate Supply

The supply potential of the economy has been boostedby a series of beneficial shocks such as

Impact of rapid technological advances Reductions in the international prices of commodities and capital

goods

Higher productivity which drives down unit cost of production

Exploitation of economies of scale leading to lower LRAC Excess supply in some industries due to over-investment in new

capital machinery i.e. deflation results from a persistent demanddeficit over existing and potential productive capacity.

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Deflation good and bad points!

http://news.bbc.co.uk/1/hi/business/7956654.stmhttp://news.bbc.co.uk/1/hi/business/7960816.stmhttp://news.bbc.co.uk/1/hi/business/8057695.stm

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Consequences of Deflation Holding back on spending: Consumers may opt to postpone demand if they expect prices to fall

further in the future

Debts increase: The real value of debt rises when the general pricelevel is falling and a higher real debt mountain can be a drag onconfidence Mortgage payers on fixed mortgage interest rates will see the real cost of

servicing their debt increase

The real cost of borrowing increases: Real interest rates will rise ifnominal rates of interest do not fall in line with prices

Lower profit margins: This can lead to higher unemployment asfirms seek to reduce their costs.

Confidence and saving: Falling asset prices such as price deflationin the housing market hit personal sector wealth and confidence

leading to further declines in AD. Higher savings can lead to theparadox of thrift

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Or.

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January 2006 - inflation

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The questions