Glossary of Unit 2 : Managing the economy

Aggregate Demand — total spending on goods and services in an economy; components are Consumption (C) + Investment (I) + Government Spending (G)+(Exports (X)– Imports (M)).

Aggregate Supply — the total amount of output in an economy.

Balance of Payments — record of a country’s transactions with the rest of the world.

Base year — a year chosen as a good comparison in a series of data, when building an index.

Bottlenecks — a constraint on the supply side of the economy which causes costs of aggregate supply to rise as the economy grows. An example is the effect of the Olympics in East London. The use of fully-qualified builders for the Olympics creates a shortage elsewhere, making costs more generally rise in the region.

Business cycle — the tendency of economic activity to rise above and below the trend rate of economic growth.

Budget — the annual statement by the Government of its intentions to tax and spend in future years. It usually comes in March, just before the start of the new tax year in April. In recent years a ‘pre-budget report’ has been delivered in December so that the budget is more predictable.

Budget surplus — the amount by which tax revenue exceeds government spending.

Budget deficit — the amount by which government spending exceeds tax revenue.

Claimant Count — a measure of those claiming unemployment benefits (not all those who are eligible — many do not claim).

Circular flow of income — a simple model of the economy which shows the movement of goods and services between households and firms, and their corresponding payments in money terms.

Constant prices — where the effects of inflation have been taken out.

Consumer Price Index (CPI) — the measure of the average level of prices. Increases in the CPI are known as inflation, and this is used as a target for monetary policy since 2003. It excludes housing costs.

Consumption — total planned household spending.

Cost of living — a measure of how much has to be spent to maintain living standards. It is usually measured by comparing the prices of a selection of items known as the ‘basket of goods’, and persistent increases in this cost is measured in an inflation index.

Current account of the balance of payments — a record of a country’s trade of exports, imports, investment income and current transfers with the rest of the world.

Current Prices — the effects of inflation have been left in.

Decile — when data is presented in a serial order, a decile marks boundaries between 10% band widths. Deciles are used for comparison between sets of data, and have the advantage that they are not distortions on the extremes of a distribution.

Demand-side policies — policies used by government to shift aggregate demand. The main policies
are monetary policy and fiscal policy.

Economic Growth — a measure of the increase in either real GDP or potential GDP.

Equilibrium National Income or Equilibrium Level of Output — the level of income or output at which aggregate demand equals aggregate supply.

Employment rate — the percentage of those in the workforce (those able and willing to work) who
are in employment.

Exchange Rate — the price of one currency in terms of another.

Exports — the value of goods and services sold abroad. These are shown in the circular flow of income as money coming into the country, that is, an injection.

Family Expenditure Survey — a survey collecting personal diaries of expenditure by families and individuals in the UK. The data is collected using computer assisted interviewing and a paper questionnaire. The response rate is around 63%.

Flow — a movement of goods and services OR the money used to pay for them, over a period of time.

Fiscal deficit — an inflationary fiscal policy, where government spending is greater than tax receipts.

Fiscal policy — the government’s manipulation of its spending and taxation in order to affect aggregate demand.

Fiscal surplus — a deflationary fiscal policy, where government spending is less than tax receipts.

Government expenditure — spending by central and local government.

Gross Domestic Product (GDP) — the total output in an economy, measured by total production by firms OR total incomes by the factors of production OR by total spending. All three measurements in theory are equal; they represent the circular flow at various points.

Hot Money — short term, speculative flows of money between countries. These may distort the exchange rate so that they do not reflect purchasing power parity. The motivation for these movements is changes in relative interest rates or expected exchange rate changes.

Human Development Index (HDI) — a measure of economic development or quality of life, composed of three equally weighted index numbers, comprising health, education and GDP per head (adjusted for exchange rate differences and inflation).

ILO (International Labour Organisation) measure of unemployment — a measure of unemployment used in most rich countries, which surveys 51 000 households (covering 101 000 people) by phone and other surveys, asking whether people have been looking for work in the past four weeks and are ready to start within the next two weeks.

Imports — the value of goods and services bought from abroad. These are shown in the circular flow of income as money leaving the country, that is, a withdrawal income. The reward paid for the use of a factor of production: rent, wages, interest or profit.

Income gap or Income inequality — a measure of the gap between the incomes of various groups within an economy often shown by plotting the average incomes of the between the lowest and highest decile (see The wage difference between these two tends to widen in periods of economic growth, and can be altered by changes to taxes and benefits.

Index — a simple way to compare data with a base year.

Inflation — a general and persistent increase in the price level — or, sustained increase in the cost of living.

Inflation Targeting — a narrowly focused monetary policy which seeks to keep the rate of inflation within a certain band, ignoring other monetary objectives.

Injections — where money flows into the circular flow, specifically investment, government spending and exports.

Interest rate — the cost of borrowing money. The Monetary Policy Committee sets the rate for very short-term loans to the commercial banks, at which they will borrow as a last resort — sometimes called the ‘bank rate’ or ‘repo rate’, and it becomes the ‘base rate’ on which banks will set their lending and borrowing rates.

Investment — an increase in the capital stock. It is determined by interest rates, confidence and the availability of credit.

Labour productivity — output per worker, or output per hour worked.

Monetary policy — decisions made using monetary instruments such as the interest rate.

Monetary Policy Committee — a group of nine economists and industrialists who meet at least once a month to set the Bank of England’s main interest rate, which, since 1997 has been responsible for UK monetary policy.

Multiplier — the number of times a rise in incomes exceeds the rise in injections that caused it. It measures the knock on effects when an injection or withdrawal changes.

National income — the total earnings in the economy of individuals, firms and government, including money earned from exports.

Net exports (X-M) — the difference between the money earned by exports less the money spent on imports. It is a component of aggregate demand.

New Deal for the unemployed — measures introduced in 1997 which aims to link unemployment benefits to attempts to get back into the job market.

Nominal values — where the effects of inflation are still incorporated in the data.

Output gap — the difference between actual real GDP growth and the potential real GDP growth. Per capita per head — GDP per head measures the average amount that each person contributes to the economy including those who contribute nothing.

Phillips Curve — this is an empirical observation that there is a possible trade off between inflation and unemployment — in other words, less of one means more of the other.

Productivity — output per unit of input. See labour productivity.

Productivity Gap — a measure of the difference between productivity levels in one country compared to others.

Real values — where the effects of inflation have been taken out.

Spare Capacity — a situation where there are unemployed resources in an economy.

Standard of living — a measure of welfare of people living in an economy.

Stock — a physical amount of goods or services that exist at a point in time, or the money that might be used to pay for them.

Supply-Side Policies — actions by government designed to promote market forces in order to increase economic growth to its potential rate. These can be achieved by increasing price flexibility, increasing competition or improving incentives in the market.

Unemployment rate — the percentage of the workforce (that is, able and willing to work) that is not currently employed.

Volume and Value — volumes measure quantities eg the number of goods sold on the export
market, and values measure the price times quantity eg the value of exported goods is £245bn (in 2006).

Wealth — a stock of assets, eg property, shares.

Withdrawals — where money flows out of the circular flow, specifically savings, taxation and imports.

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