Economics help blog – Page 108

Is inflation caused by economic growth?

5 January 201814 October 2017 by Tejvan Pettinger

Readers Question: Is rise in prices a reflection of economic growth?

A sustained rise in prices is known as inflation. A large rise in prices / higher inflation rate is often caused by economic growth.

However, there are also occasions, when we can get inflation despite weak or negative economic growth.

Inflation caused by economic growth

Typically, higher inflation is caused by strong economic growth. If Aggregate Demand (AD) in an economy expands faster than aggregate supply, we would expect to see a higher inflation rate. If demand is rising faster than supply this suggests that economic growth is higher than the long run sustainable rate of growth.

For example, in the UK, the long-run trend rate of economic growth is around 2.5%.

If the UK economy expands very rapidly, e.g. economic growth of 5%, then you expect to get inflationary pressures:

With high growth, demand rises faster than firms can keep pace with supply; faced with supply constraints, firms push up prices.
High growth leads to more employment. Unemployment falls, but this may cause labour shortages. This fall in unemployment puts upward pressure on wages which leads to higher inflation.

Private, Public and Free Goods defined

9 January 201813 October 2017 by Tejvan Pettinger

Definition and explanation of different types of goods Free good – no opportunity cost Private – Good with opportunity cost, rivalry and excludable Public good – non-rivalry, non-excludable Free Good A free good is a good needed by society but available with no opportunity cost. It is a good without scarcity. For example, air is …

How useful is pareto efficiency?

8 January 201813 October 2017 by Tejvan Pettinger

Readers Question: Pareto efficiency occurs (as you say) ‘when it is impossible to make one party better off without making someone worse off’. Assume (and Economics seems to do this a lot) two people live in the world. One is a multi-billionaire and the other has no money at all. If the rich guy gives …

Problems of Recessions

18 January 201811 October 2017 by Tejvan Pettinger

Readers Question: Identify and explain economic variables that may be affected negatively by the economic slowdown. Some of the problems of a recession include Falling Output. Less will be produced leading to lower real GDP and lower average incomes. Wages tend to rise much more slowly or not at all. Unemployment. The biggest problem of …

Problems facing UK economy post Brexit

9 January 201810 October 2017 by Tejvan Pettinger

After the UK’s decision to leave the EU, what economic problems will it face? Summary of problems Devaluation of Pound Sterling, increasing price of imported goods, such as food, oil, manufacturers and domestic inflation. This cost-push inflation is again putting pressure on real wages. WIth low nominal wage growth – inflation has led to falls …

Money Supply, M0, M3, M4 and Inflation

28 March 20229 October 2017 by Tejvan Pettinger

Definition: The money supply measures the total amount of money in the economy at a particular time. It includes actual notes and coins and also any deposits which can be quickly converted into cash. There are different measures of the money supply. Narrow Money e.g. M0 = This is the level of notes and coins …

The importance of supply-side policies

6 January 20188 October 2017 by Tejvan Pettinger

Supply side policies are government policies which seek to increase the productivity and efficiency of the economy. They can involve interventionist supply side policies (e.g. government spending on education) or free market supply-side policies (e.g. reduce government legislation)

The main macroeconomic objectives of the government include:

Higher economic growth
Low inflation
Low unemployment
Equilibrium on the balance of payments

Quite often these objectives conflict with each other. For example, expansionary fiscal policy may contribute to higher economic growth and lower unemployment; however, it will be at the cost of inflation and a deterioration on the current account.

To achieve all objectives simultaneously it is essential to improve the supply side of the economy. If the government can increase productivity and shift AS to the right, it can enable low inflationary growth and help improve the general competitiveness of the economy.

Long-run trend rate of economic growth

Supply side policies which shift LRAS to the right allow higher economic growth.

The main limitation for increasing the long-run trend rate of economic growth is the growth of productivity (output per worker). We cannot increase the long-run trend rate of growth through demand side policies. Therefore, if the government wants a higher sustainable rate of economic growth then it requires effective supply side policies which increase this productivity.

For example, effective training schemes which give workers more skills can lead to higher labour productivity. Governments could try and encourage firms to invest in more research and development by offering tax credits. If successful, these policies can enable countries to grow at a higher rate.

In practice, it is difficult for government supply side policies to improve the long-run trend rate of growth. Productivity growth depends to a large extent on technological improvements. These improvements mostly come independently of government policy.

Imports and Inflation

8 January 20188 October 2017 by Tejvan Pettinger

Readers Question: How does an increase in imports cause inflation in the economy? If the quantity of imports increases, this should reduce domestic demand-pull inflation (AD = C+I+G+X-M). Therefore if consumers spend more on imports it will, ceteris paribus, reduce domestic demand. Therefore, we get lower growth of AD and lower inflation. Suppose there is an …