Transcript Sample - Economics Online

© Economics Online 2011
1
 Income in an economy flows from one part to another and back again,
generating further incomes as it does so.
Households use their income to buy private goods
£100b
Households
Factor
s
Factors
Incomes
Spending
£100b
Firms
Goods
Goods
and services
Factor inputs are converted
into an output by private firms
The circular flow is started when firms use factors. Assume they pay a total
income to households (of £100b) for all the factors of production
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2
The trade cycle
Booms lead to:
Economic
problems arise
from the instability
of the trade cycle.
Changes in real
national income
tend to be cyclical.
It is desirable that
this cycle is stable
rather than
unstable.
Comparing actual
growth with the
trend rate is useful
for policy
purposes.
Change in
DEMANDreal
SIDE
POLICY
national
Monetary policy
income
Fiscal policy
Exchange rate policy
Regulates aggregate demand
to stabilise the trade cycle
•
•
•
•
•
•
•
Goods and service inflation
House price inflation
Wage inflation
Labour shortages
Falling savings
Excessive credit
Trade difficulties
Trend rate
Busts lead to:
•SUPPLY
Goods deflation
SIDE POLICY
•Incentives
House price deflation
•Welfare
Labourto
surpluses
work
•Education
Unemployment
and skills
long
termburden
growth
•Promotes
Excessive
debt
• Public sector debt
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Time
RPI and CPI – 1994 - 2010
Targeting inflation
6
 It is generally recognised that
a small amount of inflation is 5
acceptable. Between 1997,
when the Bank of England
was made independent, and 4
2004 the (RPI) target rate for
inflation was 2.5%.
The CPI target
UK Inflation rates (%) 1994 - 2010 (Source ONS)
RPI
CPI
3
 Since 2004, with the
2
adoption of the CPI, the
target has been 2%. The Bank
of England must act by
1
raising or lowering interest
rates to achieve this target.
0
RPI target 2.5%
CPI target 2.0%
Bank of England is
made independent
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4
Summary of the monetary transmission mechanism
Market
RISE
interest rates
AOfficial
RATE
interest
rate
INCREASE
Asset
prices
FALL
Domestic
Domesticdemand
demandTIGHTENS
inflation
Expectations
WORSEN
Exchange
APPRECIATE
rates
Import prices
Import
- cost
prices
inflation
FALL
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Inflationary
Total
PRESSURE
inflation
EASED