Economic Terms

Money that has been invested, in contrast to debt capital, which is not repaid to the investors within a fixed period of time. The fund provider instead receives a percentage of the ownership as well as future company profits. These funds can then be used to act as a buffer stock to absorb any losses companies or banks make.

Below is an example of a balance sheet for a bank and the role that capital can play in a bank. In this instance the bank has £8bn worth of capital to absorb any losses that bank may make specifically concerning non-performing loans. So as long as the bank can maintain their losses below £8bn it will always remain in a solvent position on the balance sheet - this is the main objective for many banks to ensure confidence in the bank from customers and regulators. However, if the losses exceed £8bn then the bank does not have capital to neutralise the losses and therefore becomes insolvent i.e. liabilities outstrip assets.

 

 

An economic and political union of 28 countries in Europe that has established a single market by applying standard laws across all member countries - The European Union.

An economic and political union consisting of 28 member states within the geographical boundaries of Europe. The union was formed to create a single economic area/market in which the free movement of goods, services, labour and capital takes place.

For countries to become part of the European Union the adoption of the Euro (single currency) is not necessary, as certain countries operate within the union but are not part of the Eurozone, as a result of the constricting one size fits all policies they have to take on in the process.

The Union was established as a result of the passing of the Maastricht Treaty in 1991 (established the timeline associated with the formation of the union and its member states) and since then membership has been open to countries that can meet the specific criteria of becoming a member such as: being run by a democratic government, maintaining a good human rights record and a tendency to implement sound economic policies. 

The European Union is organised and controlled by a number of important institutions, these are:

• European Commission - The executive body of the EU and responsible for proposing legislation and policies as well as identifying new policies for the single market.
• European Council - A council that comprises the heads of state or government representatives of the member states. This council has the role of voting on the policies that have been proposed by the European Commission and often this vote needs to be unanimous for the policy to follow through. 
• European Parliament - This is composed of directly elected representatives, more commonly referred to as MEPs (Members of European Parliament). The parliament stands for MEPs to give their stance of economic policies and in particular the performance of the European Commission. 
• European Court of Justice - Sets and makes judgements on EU laws currently in place, these judgements have wider impacts on the member states. 

These four institutions come together to ensure that freedom, justice and security is maintained across the entire union, whilst simultaneously creating the ideal political conditions for promoting economic and social progress in each country. In the process, this not only asserts each country's influence and role on the world stage (e.g. trade) but also Europe's role in the world. However, eurosceptic criticism has always been attached to these types of institutions, as some of the representatives are unelected and therefore hold no accountability for their actions.

Whether union membership is beneficial for a country or not all depends on the relative merits or demerits of union membership for that particular country and this all depends on the individual specifics of the country involved. 

However, in theory the benefits of a country being part of the single market are:

1. Trade Creation - By becoming part of the single market, member states benefit from increased trade as a result of trade barriers such as tariffs being removed. The fact that trade barriers are removed creates the incentive for countries to begin specialising in the production of certain goods and services and reap the benefits of economies of scale. The increased trade leads to wider economic advantages for economic agents such as prices become reduced and an increase in economic activity which fuels higher jobs within a country e.g. the UK's financial services industry.
2. Stable Economic Conditions - By becoming part of union the country is likely to benefit from the fact that political and economic certainty is achieved across all union members and this makes it easier for domestic businesses to sell their products to other union members, as all countries have to adhere to the same product standards. If firms feel more comfortable and certain with the conditions they face, it is likely to encourage them to take on new staff and engage in investment projects. 
3. Migration Benefits - The free movement of labour allows firms to take on workers where domestic skills shortages may be present. Without the ability for countries to plug these gaps it may hold back their productivity and efficiency and therefore businesses may struggle to operate. 

The costs of becoming part of the single market are:

1. Membership Cost - EU membership requires an annual fee, which could be diverted towards domestic expenditure areas such as healthcare and education.
2. Regulations - Becoming part of the EU means all member states have to abide and respect all regulations set by the European Commission and this can be very damaging for certain economies which may become restrained by the excessive regulation. This is caused because EU regulation affects all member states rather than specific states.
3. High Immigration - For certain member states, high net migration can be problematic as it increases the supply of labour for a country without accompanying increases in demand for labour. This can progressively drive down wages for domestic workers and discourage certain domestic workers out of searching for jobs. Increasing the benefit payments that governments have to pay. 

Now when it comes to evaluating European Union membership for specific countries such as the UK, you need to go further than just listing the costs and benefits against each other as this is just a form of analysis of EU membership. It is important to consider how large each cost and benefit is for a country and in particular which costs and benefits are important for each country. Considering these points allows candidates to create a more balanced and reasoned argument towards EU membership 

Some of the key evaluation points you could mention are:

• Is the EU membership fee as extravagant as perceived when compared to national government figures? e.g. the national debt for a country.
• If EU regulation was removed,  would a national government be better placed to decide upon the optimal regulation strategy for a country going forward? e.g. government failure and independence issues?
• The uncertainty of leaving a single market can create uncertainty but will this be sustained in the long-run? e.g. once trade deals have been established uncertainty would disappear over time.
• Are EU immigrants always more-suited to UK jobs when compared to domestic residents or even non-EU immigrants? e.g. all depends on the skill levels of immigrants and whether that skill set is valued in that particular country.

Economics is an uncertain science. What causes the real economy to change, how significant the changes are, how quickly they occur and how long they last for cannot be predicted with any certainty.

While economists might be able to accurately generalise whether a variable (e.g. price) is likely to rise or fall in response to a change in another variable (e.g. demand or supply), most will agree that it is almost impossible to know how large the change will be, how long it will take to emerge and how long the change will last for.

They will also recognise that although the assumption of ceteris paribus makes economic analysis easier, the real world does not reflect ceteris paribus and this nearly always means that changes in other variables will conceal or counteract the expected changes so that it seems like they didn't actually happen.

These uncertainties define what evaluation is and what students need to do in exams to convince examination markers that they have adequately demonstrated this skill.

A good way of working with this in exams is to start your answer with a ceteris paribus assumption so that you can clearly analyse the general changes you are considering and then evaluate this analysis by explaining that you understand the uncertainties attaching to the precise outcome (low level evaluation) and then identify some of the other factors that might result in a more or less significant or completely different outcome to the outcome your analysis predicts.

A really simple way of looking at this is that whenever a student analyses a chain of economic events it is crucial to clearly articulate any uncertain aspects relating to the outcome their analysis has predicted.

In an AS micro exam a simple and straightforward question might ask you to explain and evaluate why an increase in car sales might contribute to a rise in the price of oil.

Start with analysis and make sure you use a graph, label it accurately and explain all the steps involved stating with the initial equilibrium position and explain how the market transitions to the new equilibrium position.

These diagrams illustrate the market for oil and some of the possible outcomes. Analysis should start with creating a graph like the one titled normal outcome followed by an explanation.

The market is initially in equilibrium at a price of P (step 1) where the quantity demanded and quantity supplied equal each other at Q (step 2). Due to the increase in the demand for oil due to a rise in car ownership (step 3) the demand for oil shifts outwards from D to D1 (step 4) this is because cars and oil are an example of joint demand (step 5). The initial shift creates excess demand (step 6) and this drives prices higher over time (step 7) until equilibrium is re-established at P1 Q1 (step 8).

To access higher grades you will need to evaluate your analysis:

Although the price of oil is expected to rise there is always uncertainty concerning how much and how quickly the price rise will materialise. For example, a small change taking some time to materialise may have limited impact on the price of oil (see small shift) while a large and rapid increase in car ownership could have a dramatic and more immediate impact on oil prices (see large shift).

You could develop this with some more detailed analysis and evaluation (this is the key to obtaining the highest grades). The timing and size of the changes will depend on a couple of factors:

1. As the demand and supply of oil is relatively inelastic the changes in price are likely to be greater than the changes in output. There is an opportunity for further analysis here as you could draw an additional graph depicting inelastic demand and supply to illustrate the differential between price and quantity changes. You could also explain why the demand (oil is a necessity) and supply (it takes a long time to develop new oil fields) are inelastic (see difference between elastic and inelastic s/d).
2. If the changes in car ownership take place over a relatively long period of time the impact on oil prices could be offset by suppliers recognising this change and increasing oil supply. This might have the potential to result in a downward movement in price as has been evident over the last 18 months (see supply responds over time).

You will notice that the are many terms used in this explanation (definitions are shown in the various light boxes). In an exam you should aim to define some of these terms.

When the quantity customers want to buy exceeds the quantity firms are able to supply. This is resolved when firms increase prices to reduce the excess demand. This encourages supply and discourages demand until the excess is removed.

Below is a diagram to illustrate how excess demand occurs in a market. Any factor which causes an increase in demand without accompanying changes in supply will create excess demand and prices have to rise in order to maintain equilibrium.

When the quantity firms supply is greater than the quantity customers want to buy. This is resolved when firms reduce prices to sell off excess supply. Lower prices discourage supply and encourage demand until the excess is removed.

Below is a diagram to illustrate how excess supply arises in a market. In this instance an increase in supply without an accompanying increase in demand will lead to supply exceeding demand and this causes the price to fall to P1 in order for the equilibrium to be restored.

An essential element in the development of economies. It enables progression from self sufficiency to trading. In under developed economies this is enabled by barter. As economies develop and grow, barter will be replaced by a system of money as the main medium of exchange.

This is the price of a currency expressed in terms of another currency e.g. £1 will buy $1.65.

The diagram illustrates how an exchange rate is determined by the demand (generated by exports because foreign countries need the currency to purchase the domestic country's exports) and supply of the home currency (this happens because the domestic currency is supplied to acquire foreign currencies so that imports can be purchased) on the foreign exchange market. Demand and supply is generated by financial as well as physical transactions.

In this example at the point where Qd = Qs the exchange rate is ER. In modern times circa $5 trillion is traded every 24 hours. This means any imbalances in demand and supply produce almost immediate exchange rate adjustments so that the market continuously clears. As a result exchange rates are quite volatile and adjust quickly to changes in demand and supply. It should be appreciated that the majority of foreign currency transactions relate to financial transactions (approx 2/3) rather than trade in goods and services. 

Is an essential element of a normal market as it prevents free rider activity. When consumers buy a good or service they usually acquire private property rights which means that other people are excluded from using or benefiting from consumption of the good.

Changes in taxation or expenditure that are designed to inject demand into the economy.

Below are a set of graphs to show the impact of the government running an expansionary fiscal policy on the economy in an AD/AS framework. This is done through cutting taxes, increasing government expenditure or possibly both from the classical viewpoint. Regardless of whether the economy has spare capacity or not he impact of the policy is to shift the aggregate demand curve outwards to AD_2.

However, what is important when evaluating the effects of an expansionary fiscal policy is to take into account the amount of spare capacity in the economy at the time. The greater the degree of spare capacity, the more effective and the less inflationary the policy is. In the case below, when an economy has significant spare capacity, an expansionary fiscal policy shifts the aggregate demand curve outwards , as a result of spare resources in the economy being available this creates little pressure for the inflation rate to accelerate. Therefore, the final impact on the economy is to achieve short-run growth - whether that is sustained in the long-run depends on what sectors of the economy the fiscal policy targeted. This is the Keynesian viewpoint of demand side fiscal policies such as this one - creates growth without inflationary pressures due to the presence of spare capacity in the economy.

However, an alternative viewpoint could be that if the economy is at full capacity then a policy that aims to inject economic activity and demand into the economy could cause the economy to overheat and create significant inflationary pressures in the process, without the benefits of higher economic growth. So effectively in the long-run we are just moving up the LRAS curve. This tends to be the classical viewpoint on these types of policies - unless there is an accompanying LRAS curve shift then effectively the policy just becomes inflationary.