The Economy
Explain the differences between a free market economy and a centrally planned economy. Discuss one advantage and one disadvantage of each system.
A free market economy is characterized by minimal government intervention where businesses handle production, and prices are determined by supply and demand. The main advantage of a free market economy is that it offers consumers a wide choice of goods and services at competitive prices. However, a significant disadvantage is the large gap in wealth distribution between the rich and the poor.
A centrally planned economy is one where the government makes all decisions related to production and distribution of goods and services. The primary advantage of this system is the equal distribution of wealth, as the government controls resources to ensure that everyone receives what they need. The disadvantage, however, is that the lack of profit motives leads to inefficiency and low innovation among firms.
Define GDP and GNP. How do they differ in measuring economic activity?
Gross Domestic Product (GDP) measures the value of production within a country's borders, including goods and services produced by foreign companies operating domestically.
Gross National Product (GNP), on the other hand, measures the value of goods and services produced by a country's citizens and businesses, regardless of whether the production occurs domestically or abroad.
The main difference between GDP and GNP is that GDP focuses on the location of production, while GNP focuses on the ownership of the production.
Discuss the impact of inflation on consumers and businesses.
For consumers, inflation reduces purchasing power, meaning they can buy less with the same amount of money, potentially lowering their standard of living and disposable income. In response, consumers may cut back on spending or shift to lower-cost alternatives.
For businesses, inflation can increase the cost of raw materials and production, leading to higher prices for their products or services. This can reduce sales if consumers are unwilling or unable to pay the increased prices.
What are interest rates, and how can changes in interest rates affect economic activity?
Interest rates are the cost of borrowing money or the reward for saving, usually expressed as a percentage of the amount borrowed or saved. Changes in interest rates can significantly affect economic activity.
If interest rates are high, borrowing costs increase for consumers and businesses, which may lead to reduced spending and investment. High interest rates can slow down economic growth as consumer spending and business expansion decrease. Conversely, low interest rates make borrowing cheaper, which can encourage spending and investment, leading to economic expansion.
Identify two factors that cause inflation.
Demand-Pull Inflation: This occurs when demand for goods and services exceeds supply. As demand increases and outstrips supply, businesses raise prices, leading to inflation.
Cost-Push Inflation: This happens when the costs of production increase, often due to rising prices for raw materials or wages. Companies pass these increased costs onto consumers in the form of higher prices, contributing to inflation.
How does a strong national currency impact exports and imports?
A strong national currency typically leads to a decline in exports because domestic goods become more expensive for foreign buyers.
Conversely, imports become less expensive, as the strong currency increases purchasing power abroad, making foreign goods cheaper for domestic consumers.
What effect does a strong currency have on consumer behavior in the domestic market?
A strong currency increases consumers' spending power abroad, making imported goods more affordable and potentially more popular. This could lead to a shift in demand away from domestic products.
Explain the relationship between high employment levels and government tax revenue
High employment levels increase the number of people earning wages, leading to higher tax revenues from income tax (PAYE) and other related taxes. This, in turn, provides the government with more funds to spend on public services.
How might a reduction in taxes impact businesses and employment
Lower taxes can lead to higher profits for businesses, as they retain more of their earnings. This can incentivize expansion and potentially create more jobs, boosting overall employment levels
Describe the characteristics of a boom phase in the economic cycle
During a boom phase, there is an increase in demand, which leads to declining unemployment and rising inflation. Interest rates may be reduced to encourage spending, further fueling economic growth