THE ECONOMY

The Economy

The Economy

1. Apply the Keynesian Cross model to analyse how falling house prices in the UK may cause the UK macro-economy to go again into recession.

Since the peak in July 2007, house prices in the UK have fallen considerably. The main reasons why housing prices are:

* Difficult to get mortgage due to credit crunch.

* Under the affordability (housing prices high income Relations)

* The economic downturn and rising unemployment

* Nobody wants to buy the house prices are falling.

For now, the lack of mortgage finance is one of the most important factors in the decline in housing demand. The Council of Mortgage Lenders suggest that mortgage approvals have fallen to the lowest levels since 1991. Until July 2007, mortgage lenders were very competitive and eager to attract customers with mortgage products such as mortgages at 100% and high income multiple mortgages. However, the credit crisis has led banks struggling for funding, so have had to reduce their mortgages. A ration mortgages, have eliminated many mortgage products, especially the 'high risk'. They have also increased the cost of many other mortgages (see: Credit crisis explained). In particular, mortgage lenders are requiring larger deposits. This makes it difficult for first time buyers to get a mortgage.

Keynesian Cross Diagram

No Keynesian cross diagram (or chart 45 degree line), a desired total spending (or aggregate expenditure, or "aggregate demand") curve (in blue) is drawn as a line up as consumers have a greater demand an increase in disposable income, which increases with the total domestic production. This increase is due to the positive relationship between consumption and disposable income of consumers in the consumption function. Aggregate demand may also increase due to increased investment (accelerator effect), while this increase is reduced imports and tax revenues increase with income. Equilibrium in this diagram occurs when total demand, AD, is equal to the total national output, Y, (corresponding to the total national income or output). Here, total demand equals total supply.

In the diagram, the equilibrium level of production and demand is determined that the desired spending curve intersects a line that represents the equality of total income and output (AD = Y). The intersection gives the equilibrium output, Y '.

The movement towards equilibrium is mostly through changes in inventories of inducing changes in production and income. If the output current exceeds the equilibrium, inventories accumulate, encouraging businesses to reduce their production, from the economy to equilibrium. Similarly, if the production level is below the equilibrium, inventories are depleted, encouraging increased production and thus a movement toward equilibrium. This process of balance occurs when the equilibrium is stable, ie when the line AD is less pronounced than the AD = Y line

In the UK the ratio of house prices to income is 50% above the long-term average (1975-2005) Source: Economist (1) This means that many potential buyers are struggling to get a mortgage. This problem has been compounded by the credit crisis (see also: List of housing prices to income in the UK)

In particular, it is ...