2.1 Measures of Economic performance Flashcards
What two components make up the circular flow of income?
Firms and households
How does the circular flow of income work
Firms produce goods and services (making up national output)
The households produce the labor, land and capital that firms use to produce the national output the money paid into the households is called national income
Households spend their income that firms create (known as national expenditure) and the flow repeats
What can affect the circular flow of income?
Injections and withdrawals (Leakages)
What are examples of injections into the circular flow of income?
Exports
investment
government spending
What are examples of withdrawals of the circular flow of income?
Taxes
Imports
savings
What happens when injections are greater than withdrawals?
Firms increase output which will lead to increased income and expenditure
What happens when withdrawals are greater than injections?
Firms will reduce output leading to decreased spending and incomes
What does the circular flow of income suggest?
As households keep spending, and firms keep producing then national output and income will not change
When an injection is made into the circular flow, how big is the income gained from it?
The change in national income will be greater than the initial injection - known as the multiplier effect.
What is the multiplier effect?
When the fiscal multiplier effect occurs when an initial injection into the economy causes a bigger final increase in national income.
What is the multiplier effect?
When the fiscal multiplier effect occurs when an initial injection into the economy causes a bigger final increase in national income.
How do you calculate the multiplier effect?
Multiplier = Change in real GDP / Change in injections
or 1 / MPW
What factors affect the size of the multiplier?
- if people spend a high % of any extra income (a high mpc), then there will be a big multiplier effect. However, if any extra money is withdrawn from the circular flow the multiplier effect will be
very small. - Marginal Propensity to Consume (mpc). This is a persons willingness to spend money – if a worker saved all his money there wouldn’t be an increase in GDP
- Marginal Propensity to Withdraw (mpw). This is when money is withdrawn from the circular flow it includes mpt + mpm + mps
- The Marginal Propensity to Tax (mpt)
- The Marginal Propensity to Import (mpm)
- The Marginal Propensity to save (mps)
what is the definition of wealth?
The value of all asset owned by an individual or firms in an economy - it can either be physical money or assets.
What is aggregate demand?
Aggregate demand is the total demand for goods and services produced within the economy over a period of time.
What is the equation for aggregate demand?
C + I + G + (X - M)
Consumption + investment + government spending + (exports - Imports)
How does a rise in price affect AD?
Causes a contraction in AD
How does a fall in price affect AD?
Causes an expansion of demand
What does an outward shift in demand mean?
National output has increased
What does an inward shift in demand mean?
National output has been reduced
What factors lead to a fall in AD?
Fall in exports a cut in government spending Higher interest rates Decline in household wealth Increase in taxation reduced consumer spending
What can lead to an increase in AD?
Depreciation of exchange rate Cuts in taxation Increase in house prices Lower interest rates increased consumer confidence Increased value of exports increased government spending
What are the monetary policies that can be used to alter AD?
Interest rates
Supply of money
changes in the exchange rate
What are types of fiscal policy that can be used to alter AD?
Taxation changes
Government spending
Government borrowing
How do external shocks affect AD?
They can change demand suddenly, reduce output and affect employment
What are examples of external shocks?
A fall in the exchange rate
A recession in a key trading partners economy
A slump in housing and construction
Global financial events
A large change in commodity prices like oil
weather events
war/conflict that affects global trade and supply
What is consumption?
Spending done by households on goods and services
What is the main component of AD?
Consumption - it makes up 65% of aggregate demand
What are the main factors affecting consumption?
Interest rates
Consumer confidence
wealth effects
the level of employment
What is the wealth effect?
The effect on spending or incomes when asset prices change, e.g. when a consumers house is worth more, they will likely spend more as they have more finance to fall back on
How does the wealth effect affect consumption?
An increase in share prices or house prices mean that households are willing or able to spend more. If someone’s house is worth more, consumers will become more confident in spending money as they know they have a large portion of income to ‘fall back’ on
What are the main factors affecting investment?
The rate of economic growth Confidence levels interest rates risk Access to credit Government decisions Government bureaucracy Levels of taxation (mainly corporation tax)
What is investment?
An increase in capital stock
What is gross investment?
The total amount of investment before the depreciation (worsening/weakening) of any assets is taken into account
What is net investment?
The increase in capital stock minus the depreciation of capital assets
What is net trade?
The value of imports minus exports, a component of aggregate demand
What are the factors affecting net exports / trade?
Changes in real income (rising income means less exporting as AD is high enough domestically for firms)
Changes in the exchange rate ( Rising exchange rate makes imports cheaper and boosts AD in the short run but in the long run exports become less competitive and more expensive causing net exports to fall)
Changes in the state of the world economy
The degree of protectionism ( High tariffs, quotas or other restrictions on trade there will be less exporting)
Non price factors like the quality of engineering, reliability, after sales service, tariffs and transport costs.
What is AS (aggregate supply)?
The quantity of goods and services that producers in an economy are willing to supply at a given price at a given time.
What is the short run aggregate supply (SRAS)?
The relationship between planned national output and the general price level
What does the SRAS show?
How much output the economy can generate at a given price level in the short term
What does a rise in the price level do to supply and why?
A rise in price leads to an expansion in supply due to the profit incentive
It also increases the real GDP
What is in the Axis of a SRAS diagram?
Y axis = General price level
X axis = real GDP
What cause the 3 main shifts in SRAS?
Changes in resource / input prices
Business taxes, subsidies, regulation and imported costs
Supply shocks
What are some examples of external factors affecting AS?
conflicts in OPEC nations energy prices Minerals and metals prices Food prices Import tariffs / Quotas
What is the LRAS?
Long run aggregate supply is determined by all factors of production – size of the workforce, size of capital stock, levels of education and labour productivity.
If there was an increase in investment or growth in the size of the labour force this would shift the LRAS curve to the right.
What does the LRAS curve look like?
A straight vertical line
What does an outward shift in the LRAS show?
It shows an increase in an economies productive potential
What is trend growth?
The estimated rate of growth of a countries productive potential
What are the key factors affecting LRAS?
High productivity of labour and capital assets
Increased labour market participation (employment)
Gains from innovation and enterprise
Capital investment
What are the impacts of increased productivity?
Lower inflation as cost per unit decreases
Greater economic growth as increased SRAS
Lower unemployment with more growth
BoP improved as exports become cheaper and more competitive
Rise in spare capacity in the short term (not in long term)
Higher investment in capital assets as businesses have greater profits
Government spending should be able to decrease as productivity boosts
What does the Keynesian AS supply curve look like?
It is non linear, AS begins to increase exponentially
Why is the Keynesian LRAS supply curve non linear and why does it look how it does?
Because, when spare capacity in an economy is high, then the SRAS will be elastic, as a result, a rise in AD can be easily met by an increase in output without a change in prices (hence why the model starts out fairly flat. As output increases, the elasticity of the SRAS curve falls, the amount of spare capacity declines (due to diminishing returns, congestion in supply pf inputs and components as well as resource shortages as country enters full employment) As a result as the SRAS becomes more inelastic further increases in supply are all inflationary and drive up the general price level.
What are the key differences between the Keynesian view on the supply curve vs the classical view?
The Classical view is that Long Run Aggregate Supply (LRAS) is inelastic, it suggests that real GDP is determined by supply-side factors believing that increases in AD will have no impact on real GDP. Whereas, the Keynesian supply curve argues that the economy can be below full capacity in the long term and places greater importance on AD in helping save a country from a recession.
When does a macroeconomic equilibrium occur on a supply and demand diagram?
Equilibrium occurs when AD perfectly intersects with SRAS (planned output and demand are totally balanced
What happens when there is an increase in AD?
When AD increases the General Price Level increases, in turn boosting supply as suppliers produce more due to the profit incentive
What happens when there is an increase in aggregate supply?
Increase in aggregate supply means that the GPL will be lower and as a result when supply is expanded AD will also increase thanks
to the lower prices.
What happens when there is a fall in aggregate supply?
When output declines the general price level decreases
What are the Macro effects of a fall in aggregate supply?
Higher inflation in short term - less supply means prices are higher as products are rarer
Economic growth is lower as it is a negative external shock
Unemployment rises as economy slows down
BoP deteriorates as more imports need to occur
Spare capacity in the economy will increase
Business investment falls as the higher costs and lower demand mean less profit
Government fiscal balance worsens as less revenue comes from tax and more JSA must be paid
What is the equation for the multiplier effect involving MPC?
Multiplier = 1 / 1 - MPC
What is the equation for the multiplier effect involving MPW?
Multiplier = 1 / MPW
What is the equation for MPW?
MPM + MPT + MPS = MPW
What does MPM stand for?
Marginal propensity to import
What does MPT stand for?
Marginal propensity to tax
What does MPS stand for?
Marginal propensity to save
What is an output gap?
The output gap is a measure of the difference between actual output (Y) and potential output (Yf).
What is the difference between gross and net income?
Gross income is the total income before any is deducted for tax
Net income is the total income minus any deductibles
What is GNI?
includes the value of all goods and services produced by nationals – whether in the country or not (+Remittances)
