This blog has been created to provide an area for economics students to read about how economics impacts daily life. It is especially useful for students to understand the application of macroeconomics as communicated through the media and governmental websites.

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Case Study


Price Mechnism: Prices act as a signal to firms and consumers to adjust their economic behaviour. For example a rise in price encourages producers to switch into making that good but encourages consumers to use an alternative substitute product
Small firm: Companies which employ a relatively low number of workers

De-merit good: A product, such as alcohol, which consumers may overvalue but which the government believes may be harmful for consumers.

Barriers to entry: Obstacles to the entry of new firms into a market. Barriers to entry may take various forms. They may be technical barriers, legal barriers or barriers that arise from strong branding of the product.

Allocative efficiency refers to the efficiency with which markets are allocating resources. A market will be allocatively efficient if it is producing the right goods for the right people at the right price. An allocatively efficient market is therefore one which has no imperfections. This will be true when marginal cost is equal to average revenue in the market. It occurs where a firm produces at MC = AR (marginal cost pricing).

EOS: A reduction in long run unit costs which arise from an increase in production. Economies of scale occur when larger firms are able to lower their unit costs.

Externalities: The spillover effects of production or consumption for which no payment is made. Externalities can be positive or negative.


PPP: Suggests that the prices of goods in countries will tend to equate under floating exchange rates so that people would be able to purchase the same quantity of goods in any country for a given sum of money.

J Curve: The tendency for a fall in the value of the currency to worsen the balance of trade before it improves the position.

Marshall Lerner Condition: States that a devaluation (currency become weaker) will improve the current account balance (exports minus imports) if the combined price elasticities of demand for exports and imports are greater than

Trading Licence: Licences that permit firms to pollute up to a certain level. They can be bought and sold.

Trade Cycle: The tendency of economies to move, over time, through periods of boom and slump, and occurs when real GDP moves away from its trend path. The trade cycle is the fluctuations in the rate of economic growth that take place in the economy. These fluctuations appear to occur around every five years and have probably occurred ever since economies have occurred! It is the aim of all governments to try to dampen the effects of the trade cycle and get more balanced long-term growth, but so far they have had limited success. The peak of the trade cycle is usually referred to as a boom, and the trough as a recession or depression.

The multiplier is concerned with how national income changes as a result of a change in an injection, for example investment. The multiplier was a concept developed by Keynes that said that any increase in injections into the economy (investment, government expenditure or exports) would lead to a proportionally bigger increase in National Income. This is because the extra spending would have knock-on effects creating in turn even greater spending. The size of the multiplier would depend on the level of leakages. It can be measured by the formula 1/(1-MPC) where the MPC is the marginal propensity to consume.

Macroeconomic policies: Policies designed to influence the level of employment, the price level, economic growth and the balance of payments.

Fiscal Policy: The stance taken by government with regard to its spending or taxation with a view to influencing the level of economic activity. An expansionary (or reflationary) fiscal policy could mean:

1...cutting levels of direct or indirect tax
2...increasing government expenditure

The effect of these policies would be to encourage more spending and boost the economy. A contractionary (or deflationary) fiscal policy could be:

1...increasing taxation - either direct or indirect
2...cutting government expenditure

These policies would reduce the level of demand in the economy and help to reduce inflation.

Monetary Policy: The use by government of changes in the supply of money and interest rates to achieve desired economic policy objectives. They aim therefore to influence the level of economic activity. The government may want to use their monetary policy to either boost economic activity (if the economy is in a recession) or perhaps to reduce economic activity (if the economy is growing too fast, causing inflation). If they want to slow down the economy they may use contractionary (or deflationary) monetary policy. This is likely to mean:

1...increasing the level of interest rates
2...reducing the rate of growth of the money supply

On the other hand if they want to boost the economy because it is in a downturn, they may choose to use expansionary (or reflationary) monetary policy. This would mean:

1...reducing the level of interest rates
2...allowing the rate of growth of the money supply to increase

FDI: Overseas investment into a country by multinational enterprises. This investment is recorded as a credit in the balance of payments.

Fiscal Drag: When people's money income rises, dragging them into higher tax brackets. Fiscal drag is therefore referring to the effect inflation has on average tax rates. If tax allowances are not increased in line with inflation, and people's incomes increase with inflation then they will be moved up into higher tax bands and so their tax bill will go up. However, they are actually worse off because inflation has cancelled out their pay rise and their tax bill is higher. The only person that is better off is the Chancellor as he is getting more tax and hasn't had to increase tax rates. Chancellors have been known to use this as a subtle means to raise more tax revenue. To maintain average tax rates, allowances should be increased by the amount of inflation each year.

Protectionism: The practice of taking steps to protect what one sees as one's own interests. Most commonly used to describe steps taken by countries to protect their domestic industries from foreign competition.

Demand Deficient Unemployment: May also be referred to as cyclical unemployment, it arises when people are out of work because of a lack of aggregate demand. It will tend to happen mainly in recessions or downturns in the trade cycle. Keynesians argue that this shortage of demand is one of the key causes of unemployment. In other words this type of unemployment is involuntary.

Supply side policies: Government policies which create incentives for individuals and firms to increase their productivity. Supply-side policies are policies that improve the workings of markets. In this way they improve the capacity of the economy to produce and so shift the aggregate supply curve to the right. This should enable the economy to grow in a non-inflationary way. Supply-side policies are usually advocated by classical and monetarist economists who believe that free markets are the most important factor determining economic growth. Supply-side policies may include improving education and training, reducing the power of trade unions, removing regulations and so on.

Supply shock: An unplanned change in supply usually occurring because of changes in weather conditions or an external change outside the control of the company or economy.

Investment is the purchase of capital equipment. i.e. the purchase of machines, equipment, factories etc. that firms need to enable them to produce. It is usually split into two parts:

1. Replacement investment - this is where companies buy new machinery and equipment that simply replaces something they had already that was worn out or inefficient. Depreciation is often used as an approximation for this.

2. Net investment - this is where companies buy new machinery or equipment. It is this type of investment that actually adds to the capital stock of the economy.

Investment can also refer to changes in the level of stocks.