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Explain why when unemployment increases, inflation may decrease. Using the diagram provided, illustrate the relationship between unemployment and inflation in the short run.When unemployment increases, with fewer people earning the level of aggregate demand is likely to fall or increase at a slower rate. This means that any upward pressure on prices will ease, though not necessarily cease altogether.The resulting “trade off” between inflation and unemployment is illustrated by the Phillips...

The central bank has an inflation target. Inflation rises above the target. What will happen next to interest rates and aggregate demand?Central banks try to control inflation using monetary policy. In Britain the emphasis today is almost exclusively on the interest rate. To reduce the rate of inflation the central bank will raise interest rates. This means that aggregate demand will fall, first because it is more expensive to borrow money, and second because households with mortgages will...

The central bank follows an inflation target and the economy benefits from an improvement in  productivity. What will happen to interest rates?An improvement in productivity should, other things being equal, result in an increase in aggregate supply and downward pressure on prices. This means that inflationary pressures will be eased and the central bank will be able to lower its interest rate.

During the credit crisis and global recession many bankers lost their jobs. Is this demand deficit, or structural unemployment?It may well be both. Initially banking staff lost their jobs as a result of problems in their own industry. This can be classed as structural unemployment.However, the effects of the financial crisis will probably induce some demand deficit unemployment.

What is inflation and how is it measured in your economy?• Demand pull inflation • Cost push inflation • The symptom of inflation is raising prices and the rate of inflation is a measure of how fast prices are rising. In the UK there are several measures of inflation, all using index number techniques. The main ones are: a) the Consumer Price Index, CPI b) the Retail Price Index, RPI which has two distinct measures. One includes housing costs such as the mortgage interest rate. The other...

What are the three main drivers of inflation?• Demand pull inflation occurs when demand in the economy rises too quickly and supply cannot keep up. • Cost push inflation occurs when there is an increase in firms’ costs of production. Firms then look towards passing these costs onto customers through higher retail prices. • Expectations about inflation play an important role in the formation of actual inflation. If workers think inflation will be higher, then they will try to negotiate  higher...

Consumer and business confidence are increasing. Illustrate the likely consequence of these changes on aggregate demand.If business confidence improves more investment will take place, leading to a multiplier effect on national income and therefore demand. Similarly if consumers feel more confident about retaining their jobs etc. spending will increase, as will borrowing (by both firms and households).

How does an understanding of income elasticity enable a firm to manage the consequences of the business cycle?If firms understand the difference between “income inferior” goods and “normal” goods they can survive a recession by producing foods that are inferior, i.e. goods which consumers buy more of when incomes are reduced.

Identify the leakages, injections and components of aggregate expenditure in your circular flow diagram.The components of aggregate demand are spending on goods and services  (consumption), exports, government spending and investment. • Saving, imports and taxation are leakages. • Exports, government spending and investment are injections.

How might two strategically interdependent players be encouraged to co-operate with each other?A repeated game permits collusion to occur. Under a strategy of tit for tat, each player tries to co-operate as long as their opponent has always tried to co-operate in the past. Any sign of cheating and the optimal response from a competitor is to cheat going forward.

When is collusion likely to fail?Collusion requires firms to agree, rather than compete. So, when there are many firms in the industry, co-ordination and enforcement are difficult to maintain and collusion is likely to fail.

How do the assumptions of perfect competition and monopolistic competition differ?• Production in monopolistic competition is differentiated. In perfect competition products are homogenous. • Both models have a large number of competitors, and freedom of entry and exit. • In monopolistic competition the demand line is downward- sloping, whereas in perfect competition it is horizontal. • Each firm in monopolistic competition can influence its market share to some extent by changing its price...

Explain the difference between accounting profits and economic profits.• Accounting profits do not include the return to the investor/entrepreneur • Economic profits are revenues minus costs which allow for the return to theinvestor.

What barriers to entry are associated with monopolies?• Licences needed to operate in the industry• Production restricted to patent holders• Where the infrastructure required to operate in the market is so vast that it tendsto exclude new competition. This is a concept associated with natural monopoly.

Describe the key assumptions which characterise a perfectly competitive market?• A homogenous product• Innumerable buyers and sellers• No barriers to entry or impediments to exit• Perfect knowledge by all buyers and sellers• No single firm or consumer can influence price or otherwise exert market power.

The elasticity of demand for electricity is relatively price inelastic. Will a change in supply have a large, or small impact on the equilibrium price and quantity?When demand is price inelastic the slope of the demand line is steep. As a result, a change in supply will have a large impact on price, but little impact on quantity.

What is the difference between a pooling and separating equilibrium?Separating equilibrium occurs when a market splits into two clearly identified sub-markets with separate supply and demand schedules, which leads to separate prices and quantities for each sub-market. A pooling equilibrium occurs when demand and supply for two products of different quality merge or pool into one demand and supply.

At a price of £10, consumers are willing to demand 20,000 units and firms are willing to supply 20,000 units. Is this market in equilibrium?Yes, the market is in equilibrium because demand and supply are equal at 20,000 units.

What are economies of scale and what are considered to be the main source of economies of scale?Economies of scale exist in the long run and occur when an increase in all inputs leads to a greater increase in output. This productivity effect leads to a reduction in long-run costs.Sources range from the exploitation of mass production techniques to  indivisibilities and engineering relationships

How does the law of diminishing returns explain the short-run productivity of a firm?Increased productivity relates to the marginal returns associated with the employment of more variable factors with the fixed factors of production (usuallyland or capital). The law of diminishing returns states that the returns to the variable factors may first of all increase but at some point, will reach amaximum and thereafter diminish.

Explain the difference between the short and the long run.In the short run some factors of production are fixed, i.e., unable to be increased or, in some cases, decreased (e.g., any labour on long-term contracts).In the long run all factors of production are variable.

A successful advertising campaign has a slogan  which is adopted by teenagers across your economy. The diagram provided shows the state of demand before the advertising campaign is run. Illustrate what will happen to the demand for the product after the  advertising campaign is run.The demand curve will shift to the right, from D1 to D2, if the advertising campaign is successful, showing that at each price more of the product is demanded.

If a consumer’s willingness to demand a product is sensitive to a change in the price, then their elasticity of demand is elastic, or  inelastic?Definition Elasticity measures consumers’ sensitivity to price changes. Example If consumers change their demand by a large amount when the price changes by a small amount, then consumer demand is elastic. If consumer demand changes by only a small amount when price changes, then it is inelastic. So, in the case of this question, demand is...

Draw a demand line which illustrates the effect of a price reduction on consumers’ willingness to demand.In this illustration if price falls from £10 to £5 per unit, then consumers’ demand for the product increases from 5 units to 10 units per period, provided that all other demand conditions remain constant.

Which of the following is positive and which is normative?(a) It is in the long-term interest of the UK to remain in the EU.;(b) Will exit from the EU reduce UK growth rates?a) Asserts an opinion without any supporting theory. It is, therefore, a normative statement. (b) In contrast, this asks a question that can be answered using economic theory. It is, therefore, a positive statement.

How does the production possibility frontier illustrate the concept of opportunity cost?It depicts the trade-off between goods and/or services produced. As resources are used for the production of one commodity those resources cannot be used for the production of another good or service

Explain the concept of opportunity cost.Definition Opportunity cost is the value of the next best alternative which must be forgone in order to obtain a good or service.   Example For example, the cost of doing these exercises and reading this answer might be the TV you could have watched