Essay about The British Economy

1723 Words 7 Pages
Explain and illustrate the effect of this shock, and the courses of action the Government and the Bank of England are, in your opinion, likely to take as a consequence. Discuss the implications for business of both the initial shock and the following Government and Bank actions. You should assume that the Government of the day has committed itself to full employment, “prudent” public spending, and no major tax increases. The Bank has an inflation target of 2.5% pa.

A long run equilibrium is one in which the aggregate markets – financial, product and resource, are in equilibrium simultaneously This is made possible by flexible wages and prices and is represented by the intersection of the AD (aggregate demand) curve and the LRAS
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As seen in Fig 2, cost-push inflation occurs with a leftward shift of the aggregate supply curve, which is independent of any movements in aggregate demand. Because the demand for oil is highly price inelastic, producers know that they can pass on the increased costs of the oil directly to the consumer, without the need to absorb them at the firm level. They may also cut back on production slightly in the short term in order to avoid a current surplus, however, as the demand for oil would not be expected to drop significantly, this approach would be a cautionary one. A rise of the price of oil by 15 percent would stimulate a single shift in the AS curve, which is known as a supply shock – whereby there is a temporary inflation taking place while the price rise is passed through the economy. A stabilisation of prices will then take place, and thus inflation will subside. A blanket increase in the price of oil is hence known as import-price-push inflation, where the ‘import prices of a commodity increase independently of the level of aggregate demand’

In general however, good-price inflation has tended to be lower than service-price inflation. This is as a result of the fact that there is a ‘higher rate of growth of productivity in goods markets relative to services markets. Goods are traded internationally to a greater extent than services and capital equipment tends to replace labour to a greater degree in the production of