Category: Economics for Business: 8e Ch 26, 7e Ch 26













  1. What is the difference between gross and net lending?
  4. What might explain why an economy experiences credit cycles?
  7. What are the potential policy implications of credit cycles?

On 21st February 2019, the Department for International Trade (DIT) published a document outlining the UK’s progress in negotiating new free trade agreements (FTAs) with a number of non-EU countries. It advises UK firms that FTAs with Turkey and Japan will not be finalised before the official exit day from the European Union – 29th March 2019. Many business groups expressed concern at this news.

The EU has successfully negotiated a number of FTAs. These deals enable all 28 states in the European Union Custom Union (EU-CU), including the UK, to trade at preferential (i.e. lower) tariffs with over 70 non-EU countries. These include Canada, South Korea, Mexico, Israel, Norway, South Africa and Turkey. Research by the CBI estimates that UK exports to these countries were approximately £41bn in 2017 – approximately 13 per cent of all UK exports. In July 2018, the EU signed its largest ever FTA – with Japan. This deal covers 635 million people.

If the UK leaves the European Union without a deal on the 29th March, then it immediately loses membership of the EU-CU. Preferential tariffs will no longer apply to trade between the UK and the non-EU countries which signed the FTAs. Without any new arrangements in place, tariffs and quotas will revert to the non-preferential (i.e. higher) rates outlined in registered schedules with the World Trade Organization.

Given the economic significance of this trade, the UK government has spent the past two years trying to negotiate new FTAs to replace those previously agreed by the EU. For example, on February 11th, the government announced that it had signed a ‘continuity agreement’ with Switzerland covering trade worth £32bn per year. Deals have also been finalised with Chile, Israel, and the Faroe Islands that replicate the terms of the EU agreements. However, government officials informed 30 business groups in early February that it was highly unlikely that most of the new replacement FTAs would be concluded in time for March 29th.

The document published by the DIT on the 21st February confirms this position and describes the current status of most of the new FTAs as:

Engagement ongoing

For both Japan and Turkey, the outlook is more negative. The guidance states:

We will not transition this agreement for exit day.

The head of EU negotiations at the CBI commented that:

We are really concerned that firms could be blindsided by this.

The government stated that it would significantly increase the resources devoted to the trade negotiations and expected to sign more deals over the next couple of weeks.

If the UK leaves the EU on the 29th March with a deal, then it remains in the EU-CU during the 21-month transition period. Trade will still be covered by the 40 existing EU deals. This gives UK officials until the end of December 2020 to conclude a new set of FTAs.


Government information


  1. Using a demand and supply diagram, illustrate the impact of tariffs on imported goods.
  2. The EU is perhaps the most famous example of a customs union. Find out some other examples.
  3. Discuss some of the potential disadvantages of free trade.
  4. Discuss some of the advantages and disadvantages of the UK remaining in the European Union Custom Union.
  5. What is a ‘registered schedule’ at the World Trade Organization?

The distinction between nominal and real values is an incredibly important one in economics. We apply the latest GDP numbers from the ONS to show how the inflation-adjusted numbers help to convey the twin characteristics of growth: positive longer-term growth but variable short-term rates of growth. It is real GDP numbers that help us to understand better the macroeconomic environment and, not least, its inherent volatility. To use nominal GDP numbers means painting a less than clear, if not inaccurate, picture of the macroeconomic environment.

The provisional estimate for GDP (the value of output) in the UK in 2018 is £2.115 trillion, up 3.2 per cent from £2.050 trillion in 2017. These are the actual numbers, or what are referred to as nominal values. They make no adjustment for inflation and reflect the prices of output that were prevailing at the time. Hence, the figures are also referred to as GDP at current prices.

The use of nominal GDP data can be something of a problem when we compare historical values. In 1950, for example, as we can see from Chart 1, nominal GDP in 1950 was a mere £12.926 billion. In other words, the nominal figures show that the value of the country’s output was 163.595 times greater in 2018 (or an increase of 162,595 per cent). However, if we want to make a more meaningful comparison of the country’s national income we need to adjust for inflation. (Click here to download a PowerPoint copy of the chart.)

If we measure GDP at constant prices we eliminate the effect of inflation. This allow us to make a more meaningful comparison of national income. Consider first the real GDP numbers for 1950 and 2018. GDP in 1950 at 2016 prices was £373.9 billion. This is higher than the nominal (current-price) value because prices in 2016 were higher than those in 1950. Meanwhile, GDP in 2018 when measured at 2016 prices was £2.034 trillion. This real value is smaller than the corresponding nominal value because prices in 2016 where lower than those in 2018.

Between 1950 and 2018 there was a proportionate increase in real GDP of 5.439 (or a 443.9 per cent increase). Because we have removed the effect of inflation the real growth figure is much lower than the nominal growth figure. Crucially, what we are left with is an indicator of the growth in the volume of output. Whereas nominal growth rates are affected both by changes in volumes and prices, real growth rates reflect only changes in volumes.

Consider now output growth between 2017 and 2018. As we saw earlier, the nominal figures suggest growth of 3.2 per cent. In fact, GDP at constant 2016 prices increased from £2005.4 trillion in 2017 to £2,033.6 trillion in 2018: an increase of 1.4 per cent. This was the lowest rate of growth in national output since 2012 when output also grew by 1.4 per cent. In 2017 national output had increased by 1.8 per cent, the same increase as in 2016.

To put the recent growth in national output into context, Chart 2 shows the annual rate of growth in real GDP each year since 1950. Across the period, the average annual rate of growth in real GDP and, hence, in the volume of national output was 2.5 per cent. In the current decade growth has averaged only 1.9 per cent. This followed falls of 0.3 per cent and 4.2 per cent in 2008 and 2009 respectively as the effects of the financial crisis on the economy were felt. (Click here to download a PowerPoint copy of the chart.)

By plotting the percentage changes in real GDP from year to year, we get a much clearer sense of the inherent instability that we identified at the outset as a characteristic of growth. This is true not only for the UK, but economies more generally. This instability is the key characteristic of the macroeconomic environment. It influences and informs much of what we study in economics.

The variability of growth rates that create the instability of economies again requires an understanding of the distinction between nominal and real GDP. Chart 3 illustrates the growth in GDP both in nominal and real terms. The average annual rate of growth of nominal GDP is 7.8 per cent, considerably higher than the average real growth rate of 2.5 per cent per year. The difference again reflects the effect of rising prices. (Click here to download a PowerPoint copy of the chart.

Chart 3 clearly shows the wrong conclusions that can be drawn if one was to focus on the growth in nominal GDP from year to year. Perhaps the best example is 1975. In this year nominal GDP grew by 24.2 per cent. However, the volume of national output contracted: real GDP fell by 1.5 per cent. The growth in nominal GDP reflects the rapid growth in prices seen in that year. The economy’s average price level (the GDP deflator) rose by 26.1 per cent. Hence, the growth in nominal GDP reflected not an increase in the volume of output – that fell – but instead a large increase in prices.

The importance of the distinction between nominal and real GDP is further demonstrated by the fact that since 1950 nominal GDP has fallen in only one year. In 2009 nominal GDP fell by 2.7 per cent. The 1.6 per cent rise in the economy’s average price level was not enough to offset the fall in the volume of output of just over 4.2 per cent. In other years when the volume of output (real GDP) fell, the effect of rising prices meant that the value of output (nominal GDP) nonetheless rose.

So to conclude, the distinction between nominal and real GDP is crucial when analysing economic growth. To understand the distinction gives you a truly real advantage in making sense of the macroeconomic environment.



  1. What do you understand by the term ‘macroeconomic environment’? What data could be used to describe the macroeconomic environment?
  2. When a country experiences positive rates of inflation, which is higher: nominal economic growth or real economic growth?
  3. Does an increase in nominal GDP mean a country’s production has increased? Explain your answer.
  4. Does a decrease in nominal GDP mean a country’s production has decreased? Explain your answer.
  5. Why does a change in the growth of real GDP allow us to focus on what has happened to the volume of production?
  6. What does the concept of the ‘business cycle’ have to do with real rates of economic growth?
  7. When would falls in real GDP be classified as a recession?
  8. Distinguish between the concepts of ‘short-term growth rates’ and ‘longer-term growth’.
  9. Why might the distinction between nominal and real be important when analysing changes in people’s pay? What would be the significance of an increase in real pay?

How would your life be without the internet? For many of you, this is a question that may be difficult to answer – as the internet has probably been an integral part of your life, probably since a very young age. We use internet infrastructure (broadband, 4G, 5G) to communicate, to shop, to educate ourselves, to keep in touch with each other, to buy and sell goods and services. We use it to seek and find new information, to learn how to cook, to download music, to watch movies. We also use the internet to make fast payments, transfer money between accounts, manage our ISA or our pension fund, set up direct debits and pay our credit-card bills.

I could spend hours writing about all the things that we do over the internet these days, and I would probably never manage to come up with a complete list. Just think about how many hours you spend online every day. Most likely, much of your waking time is spent using internet-based services one way or another (including apps on your phone, streaming on your phone, tablet or your smart TV and similar). If your access to the internet was disrupted, you would certainly feel the difference. What if you just couldn’t afford to have computer or internet access? What effect would that have on your education, your ability to find a job, and your income?

Martin Jenkins, a former homeless man, now entrepreneur, thinks that the magnitude of this effect is rather significant. In fact, he is so convinced about the importance of bringing the internet to poorer households, that he recently founded a company, Neptune, offering low-income households in the Bronx district of New York free access to online education, healthcare and finance portals. His venture was mentioned in a recent (and very interesting) BBC article – a link to which can be found at the end of this blog. But is internet connectivity really that important when it comes to economic and labour market outcomes? And is there a systematic link between economic growth and internet penetration rates?

These are all questions that have been the subject of intensive debate over the last few years, in the context of both developed and developing economies. Indeed, the ‘digital divide’ as it is known (the economic gap between the internet haves and have nots) is not something that concerns only developing countries. According to a recent policy brief published by the New York City Comptroller:

More than one-third (34 percent) of households in the Bronx lack broadband at home, compared to 30 percent in Brooklyn, 26 percent in Queens, 22 percent in Staten Island, and 21 percent in Manhattan.

The report goes on to present data on the percentage of households with internet connection at home by NYC district, and it does not take advanced econometric skills for one to notice that there is a clear link between median district income and broadband access. Wealthier districts (e.g. Manhattan Community District 1 & 2 – Battery Park City, Greenwich Village & Soho PUMA), tend to have a significantly higher share of households with broadband access, than less affluent ones (e.g. NYC-Brooklyn Community District 13 – Brighton Beach & Coney Island PUMA) – 88% of total households compared with 58%.

But, do these large variations in internet connectivity matter? The evidence is mixed. On the one hand, there are several studies that find a clear, strong link between internet penetration and economic growth. Czernich et al (2011), for instance, using data on OECD countries over the period 1996–2007, find that “a 10 percentage point increase in broadband penetration raised annual per capita growth by 0.9–1.5 percentage points”.

Another study by Koutroumpis (2018) examined the effect of rolling out broadband in the UK.

For the UK, the speed increase contributed 1.71% to GDP in total and 0.12% annually. Combining the effect of the adoption and speed changes increased UK GDP by 6.99% cumulatively and 0.49% annually on average”. (pp.10–11)

The evidence is less clear, however, when one tries to estimate the benefits between different types of workers – low and high skilled. In a recent paper, Atasoy (2013) finds that:

gaining access to broadband services in a county is associated with approximately a 1.8 percentage point increase in the employment rate, with larger effects in rural and isolated areas.

But then he adds:

most of the employment gains result from existing firms increasing the scale of their labor demand and from growth in the labor force. These results are consistent with a theoretical model in which broadband technology is complementary to skilled workers, with larger effects among college-educated workers and in industries and occupations that employ more college-educated workers.

Similarly, Forman et al (2009) analyse the effect of business use of advanced internet technology and local variation in US wage growth, over the period 1995–2000. Their findings show that:

Advanced internet technology is associated with larger wage growth in places that were already well off. These are places with highly educated and large urban populations, and concentration of IT-intensive industry. Overall, advanced internet explains over half of the difference in wage growth between these counties and all others.

How important then is internet access as a determinant of growth and economic activity and what role does it have in bridging economic disparities between communities? The answer to this question is most likely ‘very important’ – but less straightforward than one might have assumed.




  1. Is there a link between economic growth and internet access? Discuss, using examples.
  2. Explain the arguments for and against government intervention to subsidise internet access of poorer households.
  3. How important is the internet to you and your day to day life? Take a day offline (yes, really – a whole day). Then come back and write about it.

Consumer and business confidence reflect the sentiment, emotion, or anxiety of consumers and businesses. Confidence surveys therefore try to capture these feelings of optimism or pessimism. They aim to shed light on spending intentions and hence the short-term prospects for private-sector spending. For example, a fall in confidence would be expected to lead to a fall in consumption and investment spending. This is particularly relevant in the UK with the ongoing uncertainty around Brexit. We briefly summarise here current patterns in confidence.



The chart nicely captures the collapse in confidence during the global financial crisis in the late 2000s. The significant tightening of credit conditions contributed to a significant dampening of aggregate demand which was further propagated (amplified) by the collapse in confidence. Consequently, the economy slid in to recession with national output contracting by 6.3 per cent during the 5 consecutive quarters during which output fell.

To this point, the current weakening of confidence is not of the same magnitude as that of the late 2000s. In January 2009 consumer confidence had fallen to an historic low of -35. Nonetheless, the December 2018 figure for consumer confidence was -9, the lowest figure since July 2016 the month following the EU referendum, and markedly lower than the +8 seen as recently as 2014. The long-term (median) average for the consumer confidence balance is -6.

The weakening in consumer confidence is mirrored by a weakening in confidence in the retail and service sectors. The confidence balances in December 2018 in these two sector both stood at -8 which compares to their longer-term averages of around +5. In contrast, confidence in industry and construction has so far held fairly steady with confidence levels in December 2018 at +8 in industry and at 0 in construction compared to their long-term averages of -4 and -10 respectively.

It will be interesting to see how confidence has been affected by recent events. The glut of stories suggesting that trading conditions were especially difficult for retailers over the Christmas and New Year period is consistent with the weakening confidence already observed amongst consumers and retailers. However, it is unlikely that recent events will have done anything other than to exacerbate the trend for a weakening of confidence of domestic consumers and retailers. Hence, the likelihood is an intensification of caution and prudence.



  5. How might prudence be expected to affect spending behaviour?