2.3 Aggregate Output, Prices, and Economic Growth Flashcards
Macroeconomics
the study of aggregate activities of households, companies, and markets
It focuses on investment, consumption, general price changes, and level of interest rates
The investment potential of firms and industries is affected by the country’s economy in which they operate
Aggregate output
the value of all goods and services produced in an economy over a specified period of time
Aggregate income
the value of all payments earned by suppliers in an economy for the production of goods and services
Over a given period, an economy’s aggregate output and aggregate income must be?
equal
There are four forms of payments (income).
- Compensation for labor, including wages and benefits
- Rent for use of property
- Interest for use of loaned funds
- Profits paid to owners for providing capital and taking on financial risk
Aggregate expenditure
the total amount of money spent on the goods and services produced in an economy during a period
the total amount of money spent on the goods and services produced in an economy during a period
Gross domestic product (GDP)
From an output perspective, GDP is the market value of all final goods and services produced within an economy during a given time period
From an income perspective, GDP is the aggregate income earned by all households, companies, and governments within an economy during a given time period
Developed countries use a standardized methodology to measure GDP. In order to ensure consistency over time and across countries, three broad criteria are used:
- All goods and services must be produced during the measurement period. Government transfer payments and capital gains are excluded.
- Include only goods and services with an objective value based on market prices.
- Exclude intermediate goods that will be resold or used in the production of other goods.
Real GDP
measures the total value of goods and services if the prices were unchanged
It removes the effects of inflation from nominal GDP
The GDP deflator
measures the aggregate price change
The Components of GDP
C: Consumer spending
I: Gross private domestic investment, including fixed assets and inventory
G: Government spending
X: Exports
M: Imports
A fiscal deficit
is recorded if the government spends more than it collects in taxes
how to finance a fiscal deficit
governments must borrow from the financial sector
A country’s exchange of goods and services with the rest of the world is measured in terms of what?
net exports
trade deficit
country imports more than it exports
Gross domestic income (GDI) calculation
net domestic income +
Consumption of fixed capital (CFC)
+
Statistical disrepancy
Personal household income (PHI)
compensation of employees
+
net mixed income from unincorporated business
+
net property income
Household disposable income (HDI)
PHI less taxes paid (net of transfers received). It measures how much households have to spend on goods or save
compensation of employees
+
net mixed income from unincorporated business
+
net property income
-
current transfers paid (personal taxes)
+
current transfers received (unemployment compensation)
Household net saving
HDI less household final consumption expenditures, plus net changes in pension entitlements
The marginal propensity to consume (MPC)
represents the proportion of an additional unit of disposable income that will be spent
The marginal propensity to save (MPS)
is the proportion f an additional unit of disposable income that will be saved
Aggregate demand (AD)
the quantity of goods and services that households, businesses, government, and foreign customers want to buy at a given price
The aggregate demand curve
looks like the demand curve from microeconomics, but the explanation is different because income is not fixed
represents the combinations of aggregate income and price level at which the following conditions are met:
- Aggregate expenditure equals aggregate income.
- The available real money supply is willingly held by households and businesses.
the downward slope of the aggregate demand curve results from which three effects?
the wealth effect
the interest rate effect
the real exchange rate effect
The wealth effect
based on the concept of purchasing power of nominal wealth
Nominal wealth does not change: one euro is always worth one euro
Real wealth, which is the value of money in terms of goods and services, fluctuates with the prices of goods and services
the interest rate effect
When the price level increases, the demand for money increases, which raises the interest rate
The higher interest rate leads to lower investment and consumption expenditures.
Conversely, when the price level decreases, the demand for money decreases, which reduces the interest rate
The lower interest rate leads to higher investment and consumption expenditures
The aggregate supply curve (AS curve)
represents the domestic output companies will supply at various price levels
In the very short run, the output will increase without price changes, resulting in a horizontal supply curve (shown by VSRAS in the diagram below).
Over slightly longer periods of time, the short-run aggregate supply (SRAS) curve is positively sloped.
In the long run, wages, prices, and expectations can change, but not physical capital. This period is usually a few years to a decade and results in a vertical supply curve
The long-run equilibrium level of supply output
the full employment level of output
Shifts in Aggregate Demand
what dies a shift to the right indicate?
an increase in aggregate demand
Shifts in Aggregate Demand
key factors
- Household Wealth
- Consumer and Business Expectations
- Capacity Utilization
- Fiscal Policy
- monetary policy
- exchange rate
- Growth in the Global Economy
Household Wealth impact on Aggregate Demand
Household wealth includes financial and real assets
Households save for future consumption
Households tend to save less when the value of their wealth is greater
An increase in wealth will increase consumer spending and thus shift AD to the right
Consumer and Business Expectations impact on Aggregate Demand
When consumers and businesses are confident about future income, they tend to spend more, which shifts AD to the right
Capacity Utilization impact on Aggregate Demand
Companies will increase investment spending if they are operating near capacity. This will move the AD curve to the right
Fiscal Policy impact on Aggregate Demand
Fiscal policy is the use of taxes and government spending to affect aggregate expenditures
An increase in government spending will shift the AD curve to the right
Decreasing the tax rate will also shift the AD curve to the right
Monetary Policy impact on Aggregate Demand
An increase in the money supply shifts the AD curve to the right
Exchange Rate impact on Aggregate Demand
If the domestic currency decreases in value relative to a foreign currency, the exports should increase and imports decrease.
his will cause the AD curve to shift to the right.
Growth in the Global Economy impact on Aggregate Demand
Faster growth in foreign markets will increase the demand for goods
Some of these goods will be provided by exporting domestic goods
This increase in exports will shift the AD curve to the right.
Factors that change the cost of production or profit margins will cause the short-run aggregate supply curve to shift.
These factors include:
- nominal wages
- input prices
3, expectations about future prices
- Business Taxes and Subsidies
- Exchange Rate
nominal wages impact on the short-run aggregate supply
Wages are often a large portion of a company’s costs. An increase in wages will shift the SRAS curve to the left
It is better to focus on unit labor cost, which takes into account productivity
Input Prices impact on the short-run aggregate supply
Higher raw material input prices will shift the SRAS curve to the left
expectations about future prices impact on the short-run aggregate supply
If a company expects the price of its products to rise in the future, it will likely increase production, provided the cost of carrying inventory is not excessive
This will shift the SRAS to the right
Business Taxes and Subsidies impact on the short-run aggregate supply
Higher business taxes will shift SRAS to the left
Higher business subsidies will shift SRAS to the right.
Exchange Rate impact on the short-run aggregate supply
If the domestic currency decreases in value relative to a foreign currency, the cost of importing raw materials will increase
This will shift SRAS to the left.
The long-run aggregate supply curve position is determined by what?
the potential GDP of the economy
that is the amount that can be produced at full employment
Increases in the following factors could shift the Long-Run Aggregate Supply (LRAS) curve to the right:
- Supply of Labor
- Supply of Natural Resources
- Supply of Physical Capital
- Supply of Human Capital
–> This is the quality of the labor force. It can be improved through training and education.
- Labor Productivity and Technology
–> Productivity measures the efficiency of labor. Advances in technology can improve this efficiency.
Equilibrium occurs where AD and AS intersect. There are four types of macroeconomic equilibrium:
Long-run full employment
Short-run recessionary gap
Short-run inflationary gap
Short-run stagflation
Long-Run Equilibrium (Full-Employment)
Long-run equilibrium occurs if the AD curve intersects the LRAS and SRAS at the same point
The economy is at potential real GDP with both labor and capital fully employed
Recessionary Gap
Recessions can occur if aggregate demand falls, shifting the short-run equilibrium to the left
the recessionary gap is the difference between the quantity supplied before the gap, and at the point of the gap
Stagflation
a case of high inflation and high unemployment
It is caused by declines in aggregate supply, which could be triggered by sudden rises in raw material costs
Inflationary gaps
occur if expansion drives the economy past its production capacity
A leftward shift in the aggregate demand curve is most likely consistent with:
A
lower taxes.
B
higher imports.
C
higher bank reserves.
B
higher imports.
Economic growth
the annual percentage change in real GDP or the annual change in real per capita GDP
Small changes in the per capita growth rate can drastically change the standard of living over time
According to the neoclassical or Solow growth model, productive capacity increases for which two reasons:
- accumulation of production inputs (capital, labor, raw materials)
- new technology that makes the inputs more productive
The neoclassical or Solow growth model
often used to determine the underlying sources of growth
diminishing marginal productivity
each additional individual input will add less to the output
economies cannot experience sustainable growth simply by adding more inputs
In other words, a strategy of simply increasing the capital input (capital deepening) can only go so far
Sources of Economic Growth
- Labor supply
–> This includes the number of people available for work and the average hours worked.
- Human Capital
–> This measures the quality of labor. Education and training can increase quality.
- Physical Capital
–> Physical capital includes buildings, machinery, and equipment. Countries that invest a lot tend to have high growth rates.
- Technology
–> Technology is the most important factor affecting economic growth. Technology is used to transfer inputs into outputs. Its impact on growth is measured by total factor productivity.
- Natural Resources
Natural resources include renewable sources (e.g., trees) and non-renewable resources (e.g., oil and coal).
The level of labor productivity depends on what?
the accumulated human and physical capital, which is greater in developed countries
