0. Macro Flashcards
what is econ
study of how an economy allocates resources and goods to various uses
3 schools of thought ;
- classical
-Keynesian
-monetarist
also macro and micro econ
Adam Smith - 4 key economic theories
- Division of labour
-key to increased productivity is to divide labour into a series of repetitive tasks perf by diff people
- spurs innovation and progress - Labour Theory of Value
-value of a good/service is determined by amount of labour req to produce it
- encourages firms to reduce costs and increase efficiency - Free market philosophy
- individuals pursuing their own self interest would result in best outcomes for society as a whole
- idea of the invisible hand - GDP
- productivity is a result of a country’s ability to accumulate capital through a series of interconnected markets
- saw economy as an interconnected system where production, consumption and exchange all influence each other to create positive or negative growth.
micro vs macro
MICRO
- studies how indivs and businesses allocate resources efficiently
-decisions concerning distro of recourses and prices of goods/servs
- Prices and equilibrium within a single market
- Production curve of a company
- customer utility curves
- Individual savings rates
- Regional housing markets
MACRO
-aggregate behaviour of a wider pop (i.e. whole economy) not just an indiv/company
- Gross Domestic Product (GDP)
-Foreign exchange rates between markets
-Interest rate levels and curves
-Consumption spending patterns
-Unemployment rates in the economy
-Inflation levels
-Government debt and taxes
-Fiscal spending and monetary policy
what is supply and demand
the provision of goods and services, the funds to pay for them, the provision of labour and the supply of wages all result from the interaction between households and firms
Key diff between Keynes + Monetarist is whether supply or demand drives initial momentum
supply and demand curves
demand curve
- downwards sloping
-quantity demanded increases as price falls
-applies to spending on goods/servs, demand for labour and loans
supply curve
- upward sloping
-businesses willing to supply more @ higher price
- applies to money supply or size of workforce @ different wage levels
4 factors of production
major inputs required for producing goods/services in order to produce income
land - rent
labour - wages
capital -interest
enterprise - profit
output = sum of returns from the factors of production in the economy
can be considered building blocks of economy
(modified circular flow of economy)
circular model showing how firms supply goods/serv to meet demand of household in return for payments (outer circle)
and how households supply labour, land, capital and entrepreneurship to meet demands of firms in return for wages, rents, interest and profits
INJECTIONS
investment - expenditure of firm when they build infrastructure
gov spending - provides capital expenditure
exports - injection of expenditure by foreign consumers
LEAKAGES
- imports - goods/servs brough into economy from foreign suppliers causing monetary outflow
- tax - money removed from flow and transferred to go (may be partially offset by expenditure)
-savings - portion of household incomes not used for current expenditure
sources/motivations/impact of these flows is what leads to different schools of econ thought
Classical school highlights
-aka free market/ capitalism / laissez faire
-no gov intervention
-consumers and producers decide on the prices of goods/serv and firms try to produce as cheaply as possible
-private ownership of production provides incentives
-wages and price are flexible causing inflation and unemployment to be temporary
Classical school - 2 big theories
The invisible hand
- metaphor for unobservable forces where decisions of indivs acting in own self interest combine @macro level to help supply of goods/serv in free market to automatically reach equilibrium
Say’s Law
- income generated by past production and sale of goods is the source of spending that creates demand to purchase current production - i.e. supply of a good/serv will create its own demand
Laffer curve
Laffer = supply side economist
shows relationship between tax rate and total tax revenue
Above optimal rate - people are disincentivized to work thus resulting in reduced revenue generation
Keynesian Econ origin
John Keynes saw classical school wasnt recuing econs from great depression - supply not generating sufficient demand
Paradox of thrift - postulates that personal savings are a net drag on the economy during a recession tho it makes sense on a household level to reduce spending during tough times
-disconnect between indiv and group rationality
- calls for lowering rates to boost spending during a recession
Keynesian economics
central belief = gov intervention can stabilize economy
mixed econ - guided by priv sector with gov intervention
economy lead by demand
advocated net gov spending (more than it receives through taxes)
Principle concern in unemployment - wages are downward sticky leading to rise in unemployment during recession
MPC
Marginal propensity to consume - Keynesian Econ
considers what proportion of any additional unit of income would be spent vs saved i.e. amount of disc spending i.e. MPC
MPS = 1-MPC
MPS = marginal propensity to save
MPC is not constant- can change due to confidence levels of indivs and their appetites
income is primary influence but others include accumulated net worth, stage in business cycle etc
Private sector demand
Inc spent by households is considered to be consumption income
Consumption function (C) - expresses how much inc will be spent
C = a + cY
c= MPC
C= total amount consumed
a=min amount of consumption required for survival
Y = total disposable income
When C is below Y=E then income exceeds expenditure implying savings
Where C is above, consumption is funded elsewhere (prev savings, debt, benefits etc)
Aggregate demand
Keynes - no natural tendency for econ to operate @ full employment, instead gov much manage agg demand
- can do this by stimulating priv sector investment, increasing gov spending, increasing exports/reducing imports, decreasing savings and taxation
Agg demand = C + I + G + (X-M)
C= planned cons expenditure
I = planned inv expenditure by bus
G=planned gov expenditure
X-M = planned net exports
Multiplier effect
ME in closed econ = 1 / (1-MPC)
According to multiplier effect : effect of any government investment on a capital project would be more than the value of the injection
way to manage demand via increased gov expenditure/ stimulating investments/increase exports or decreasing savings/tax
Multiplier effect and money supply
Keynesian econ
Lending deposits by banks increases money supply without increasing actual amount of currency (credit creation) - should theoretically lower interest rates, generate more investment, increase spending as more £ in consumer hands
CB/govs can tighten money supply by increasing reserve reqs - which increases lending selectivity of banks
Basel III
- implemented in 08, imposed greater minimum cap reqs on banks
-introduced liquidity cover ration and net stable funding ratios
Philips curve
Adopted by Keynesian economists
suggests inverse relationship between unemployment and inflation acc to 19th/20th century data
if unemployment is high, wages rise only moderately. Conversely, if unemployment is low then wages rise more strongly, on the basis that there is less surplus labour available, so firms must pay more to counteract the scarcity of supply
relationship can vary by economy and across industries
curve has flattened in recent decades due to increased globalization and digitization/decreased unionization/increased migration to Uk from other countries increasing supply of labour
Monetarism origin
Milton Friedman - believed Keynesian distorted true supply/demand
belief that manipulation of aggregate demand and increased money supply lead to stagflation in 70s
monetarists have more in common with classical economist than keynesian, but classicals reject key tenet of monetarism
= the most important policy is to maintain control of money supply
market should be allowed to work efficiently but with controlled money supply
principle concern is inflation - distorts markets and must be addressed before any other economic issues
Monetarists view on money supply
Believe that as money supply increases - demand increases - production increases so jobs increase.
increased money supply = short term boost to economy
over LT, demand will outstrip supply, prices will rise to match leading to inflation
Fisher Equation
Monetarism is based on Fisher eq
MV = PT
M= money supply
V=velocity of circulation
P= avg price
T = total volume of transactions
Monetarists argue V is stable over time and T is grows SLOWLY as productive capacity of economy gradually expands SO relationship between M&P is the key to determining level or prices
Natural unemployment
Monetarists believe that natural unemployment arises due to misperception by employers of true supply conditions of labout in the market
=the unemployment rate that persists in a well-functioning, healthy economy that is considered to be at “full employment” - hypothetical rate that says employment will never be 0
so = unemployment can be explained through frictions and distortions in labour market (e.g. immobility of labour/inadequate training) on the basis they bring about mispricing of labour
Supply side economics
Monetarist critique of labour market gave rise to Supply side econ - school of through t advocated for by monetarists
-markets should be as free as poss
- removal of supply side frictions (in labour market, taxation, customs on international trade) will remove distortions in market and allow supply and demand to work properly
belief that demand manafement will produce full employment, but also expand money supply and create inflation
core principles of econ schools
role of gov
fiscal policy
supply
demand
inflation
wages
unemployment
Application of economic theories
Economic theories are implemented by politicians not economists
two barriers to pure application
1.political compromise
2.open vs closed economies
- closed = less dependent on foreign trade/investment
Keynesian policies adopted during times of low international trade - increased globalization/more international trade/dependency on international trade/funding deficits = reduced need for keynesian policies
easier to adopt pureer forms of econ theory if economy is insulation from FX fluctuations ‘(e.g. eurozone)
business/economic cycle
PEAK
- GDP grows rapidly + high levels of activity. Bis operating @ full capacity, low unemployment, inflationary pressures, deterioration in balance of payments, asset prices subject to bubbles
- IR increased to dampen demand and inflation
CONTRACTION
- slump/deceleration - GDP typically contracts (or grows more slowly) due to demand reduction
- unemployment increases
-recession if GDP contracts for >2 consecutive quarters
TROUGH
- slowing ceases, economy hits a bottom from which recovery emerges
-high unemployment, weal reatil sales, deflation
-IR cut to boost the economy
RECOVERY
-expansion/acceleration
- economy is growing - if this lasts long enough economy will enter a boom period
GDP vs GNP
Gross domestic product (GDP) is the value of the finished domestic goods and services produced within a nation’s borders.
Gross national product (GNP) is the value of all finished goods and services produced by a country’s citizens, both domestically and abroad
GNIhas broadly replaced GNP
Perfect competition
Microeconomics
PC = theoretical representation of how a free market would operate where no one buyer/seller can influence price of a single homogeneous product
PC firm operates in industry w/ infinite number of firms, each accepting market price of homogeneous product set by interaction of supply/demand
PC generates normal profits i.e.e enough to cover total costs and remain competitive
Characteristics of perfectly competitive industry
- No one firm dominates
- Firms do not face any entries to barriers
- A single homogenous product is produced by all firms
- There is a single market price and place at which all output produced by 1 firm can be sold
- Infinite number of consumers
- Perfect information about the product, price and firms’ outputs is
available to all
If one firm was earning ‘supernormal profits’, then other firms would enter the market, supply the good, and thereby drive down the availability of profits until the supply matched the demand and supernormal profits were eroded.
Monopoly and oligopoly
Occurs when comps gain market power allowing them to take advantage and create inefficiencies due to imperfect competition
-i.e. artificially fixing prices and moderating output
Monopoly = single market supplier of prod
oligopoly = limited number of highly independent firms dominate the industry
UK public utilities/ tech companies often operate @ near monopolies
asymmetry of information
Different degrees of knowledge available to parties in a transaction
- e.g. borrower and lender (borrower has more info about their financial state than lender)
can lead to frictions in labour market - fluctuations in unemployment and sluggish wage growth
- employer cannot know how hard prospective employee will work
information gaps lead to
- adverse selection
-inefficient resource allocation
-incorrect setting of prices
=and therefore can lead to market failure
Production Costs and Economies of Scale
Firms maximise profit by producing @ level of output where marginal costs are equal to marginal revenue
- firms will produce additional unit where extra rev generated by sale =cost of production
output must exceed production costs to make normal profit
as firms productive capacity increases - they can benefit from economies of scale - lowering costs and making production more efficient
production cost minimised @ MES (min. efficient scale)
beyond this point = diseconomies of scale
may be caused by lack of space for employees to work at max capacity e.g.
effect of inflation on asset classes (5)
which sectors may be in favour @ each point of economic cycle
assuming investors know where in cycle the economy is and the extent to which the sector is operationally geared to the cycle
- doesnt provide latitude for sudden events that may spark sudden flight between asset classes
problems of inflation
Balance of payments
compares inflows and outflows of all exports and imports to provide a balance
- positive balance = more money flowing in
-negative balance = more money flowing out
3 accounts must balance collectively
CURRENT ACC (balance of trade)
- imports and exports
-ST flows of money in and out
-visibles (products)
-invisibles (services)
CAPITAL ACC - financial transactions not affecting income, production or saving e.g. copyright
FINANCIAL ACC - transactions for increases/decreases in the ownership of assets
+balancing item - to correct any statistical error and ensure accounts balance
PPP
PURCHASING POWER PARITY
Econ theory - states that exchange rate between 2 currencies is in equilibrium when their domestic purchasing powers are equivalent
i.e. if big mac if 5 USD and 5USD is 4GBP then big mac should be 4GBP
compares economic productivity and standards of living between countries
Drawbacks
- tax differences
-tariffs on imported goods
Nominal GBP values can be misleading because currencies may be manipulated. GDP by PPP allows a fairer comparison of GDP between countries with different currencies
International Fisher Theory
diff in nominal IR rates between 2 countries will determine movement of exchange rates
(1+r)=(1+i)(1+R)
