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Economics AS > 2.4 > Flashcards

2.4 Flashcards

1
Q

What is an open economy ?

A

An open economy is one in which there is foreign trade

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2
Q

What is a closed economy ?

A

A closed economy is one in which there is no foreign trade

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3
Q

What is the circular flow of income ?

A
  • Households own the factors of production
  • They supply these factors of production to firms
  • Firms then use these factors of production to produce goods and services
  • In return for providing the factors of production, households receive income, rent, wages and profit
  • Households, then use some of the rewards to purchase goods and services from firms
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4
Q

What are the three ways of measuring the level of economic activity ?

A
  • National output (O) - The value of the flow of goods and services from firms and households
  • National expenditure (E) - The value of spending by households on goods and services
  • National Income (Y) - The value of income paid by firms to households in return for land, labour and capital
  • O ≡ E ≡ Y
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5
Q

What is the equation for aggregate demand (AD) ?

A
  • Consumer expenditure + Investment + Government expenditure + (exports-imports)
  • C + I + G + (X-M)
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6
Q

What is wealth ?

A
  • Wealth is the value of a stock of assets owned by someone
    • Savings in bank accounts
    • Ownership of real estate
    • Shares/stocks in a business
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7
Q

What is income ?

A
  • Income is the flow of money going to factors of production
    • Wages and salaries
    • Rental income from property
    • Interest from savings
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8
Q

What is the Gini coefficient ?

A
  • The gini coefficient is commonly used to measure income inequality, 0-1
  • The higher the number, the greater the degree of income inequality
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9
Q

What is an Injection ?

A

An injection into the circular flow is a monetary addition to the economy

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10
Q

How could you remember the injections ?

A
  • IGE
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11
Q

What are the three injections ?

A
  • Investment - spending by firms on new capital equipment like factories, offices and machinery
  • Government spending - Spending by central, local and other government agencies
  • Exports - spending by foreigners on goods and services made in the UK
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12
Q

What is a withdrawal ?

A

Where money is removed from the economy

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13
Q

How could you remember the withdrawals ?

A

STI

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14
Q

What are the three withdrawals ?

A
  • Saving by households/firms - Money which is saved and not spent by households or firms
  • Taxes paid to the government - Taxes take money from both households and firms
  • Imports - Goods and services that are bought from abroad by both households and firms
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15
Q

What happens when injections are larger than withdrawals ?

A

Higher spending to reflect a rise in national income

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16
Q

What happens when withdrawals are larger than injections ?

A

Lower spending to reflect a fall in national income

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17
Q

What do Keynesian and classical economics agree about the AD curve ?

A

In the short run, the AD curve is downward sloping whilst the AS curve is upward sloping

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18
Q

Where is the equilibrium level of output (short run) ?

A

It occurs at the intersection of the AD and AS curves.

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19
Q

How does an increase in AD shift the curve ?

A

An increase in AD shifts the curve to the right

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20
Q

What are the components of AD ?

A
  • Consumption
  • Investment
  • Government spending
  • Exports - Imports
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21
Q

How will an increase in these components affect AD ?

A

An increase in the components of AD will increase AD and therefore shift the curve to the right

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22
Q

Describe the rise in AD in the short run

A
  • AD curve shifts from AD1 to AD2

- Equilibrium output then rises from Y1 to Y2 whilst the price level rises from P1 to P2.

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23
Q

What does a rise in AD increase ?

A

A rise in AD increases both real output and the price level in the short run

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24
Q

How does a decrease in AD shift the curve ?

A

A decrease in AD shifts the AD curve to the left

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25
Q

How will a decrease in the components of AD affect AD ?

A

A decrease in the components of AD will decrease AD and therefore shift the curve to the left

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26
Q

What does a fall in AD decrease ?

A

A fall in AD will lead to both a fall in real output and the price level

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27
Q

How does a fall in SRAS in the short run shift the curve ?

A

It shifts the curve upwards and leftwards

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28
Q

What are some of the factors that can cause a fall in SRAS in the short run?

A
  • Wages of workers might rise
  • Raw material prices may go up
  • Taxes on goods and services might be raised
  • Anything that decreases supply
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29
Q

Describe the fall in SRAS in the short run

A
  • The SRAS curve shifts from SRAS1 to SRAS2.

- Equilibrium output then falls from Y1 to Y2. At the same time, the price level rises from P1 to P2.

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30
Q

What does a fall in SRAS in the short run cause ?

A

A fall in SRAS therefore leads to a fall in output but a rise in the price level in the short run

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31
Q

How does a rise in SRAS in the short run shift the curve ?

A

It shifts the curve downwards and to the right

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32
Q

What are some of the factors that can cause a rise in SRAS in the short run?

A
  • Wages paid may decrease
  • Raw material prices may go down
  • Taxes on goods and services might fall
33
Q

What does a rise in SRAS in the short run cause ?

A

A rise in SRAS will lead to a rise in equilibrium output and a fall in the price level

34
Q

Where is the equilibrium level of output (long run) ?

A

It occurs at the intersection of the LRAS curve and the AD curve

35
Q

How does an increase in AD affect the AD curve ?

A
  • It pushes the curve to the right

- But the classical and Keynesian models are different

36
Q

What determines a shift in the AD curve ?

A
  • A change in the determinants of aggregate demand

- C, I, G and X-M

37
Q

What does the LRAS curve show (classical economics) ?

A
  • It shows the supply curve for an economy at full employment
38
Q

What does the LRAS curve mean ?

A

This means there can be no unemployment in the long run, according to classical economists

39
Q

Describe the rise in AD in the classical model

A
  • AD curve shifts to the right from AD1 to AD2.

- The equilibrium price level rises from P1 to P2 but equilibrium real output remains the same at Q.

40
Q

What does a rise in AD lead to ?

A

A rise in the price level but no change in real output in the long run

41
Q

What does the Keynesian LRAS curve show ?

A

The economy is at full employment where the curve is vertical but it can be in disequilibrium at less than full employment and in recession when horizontal

42
Q

Describe the rise in AD in the Keynesian model

A
  • The AD curve rises along the LRAS curve

- Goes sideways until the LRAS curve is straight and then it goes upwards

43
Q

What does a rise in AD lead to ?

A
  • It could lead to many things, depending on where the increase is
  • The shift in aggregate demand from AD1 to AD2 will increase equilibrium output from Y1 to Y2 without raising the price level from P
  • A rise in aggregate demand from AD3 to AD4 will increase both equilibrium output and equilibrium prices.
  • AD4 to AD5 there will only be an increase in the price level and no change in real output
44
Q

What is the point of disagreement between the two economic ideas ?

A

The extent to which workers react to unemployment by accepting real wage cuts

45
Q

What do classical economists argue ?

A
  • A rise in unemployment will lead to cuts in real wages
  • These cuts will increase the quantity demanded of labour and reduce the quantity supplied, returning the economy to full employment quickly and automatically
46
Q

What do Keynesian economists argue ?

A
  • They argue that wages are sticky downwards
  • Workers will refuse to make wage cuts and will fiercely resist cuts in their real wage
  • The labour market will therefore not clear except perhaps over a very long period of time
47
Q

What does a rise in LRAS mean ?

A

A rise in LRAS means that the potential output of the economy has increased

48
Q

What might cause a rise in the LRAS ?

A
  • Increased incentives to work

- Improvements in technology

49
Q

Describe the rise in LRAS in the classical model

A

A shift in the aggregate supply curve from LRAS1 to LRAS2 will increase equilibrium output from Y1 to Y2. Equilibrium prices will also fall from P1 to P2.

50
Q

What does a rise in LRAS lead to ?

A

Both higher output and lower prices

51
Q

Describe the rise in LRAS in the classical model

A
  • A shift in the aggregate supply curve from LRAS1 to LRAS2 increases full employment equilibrium output from YE to YF.
  • If the economy is at slightly less than full employment, with an aggregate demand curve of AD2, then the shift to the right in the LRAS curve will still be beneficial to the economy, increasing output and reducing prices.
  • If the aggregate demand curve is AD3, an increase in aggregate supply has no effect on equilibrium output. It remains obstinately stuck at YD.
52
Q

What does a rise in LRAS lead to ?

A

It will increase output and reduce prices if the economy is at full employment

53
Q

What is the multiplier effect ?

A

The multiplier effect is when injections into the circular flow of income eventually lead to an even bigger increase in national income

54
Q

How is the multiplier determined ?

A
  • The multiplier is determined by the size of the withdrawals from the circular flow
  • The larger the withdrawals are the lower the multiplier will be
55
Q

What is the multiplier ratio ?

A

The multiplier ratio (K) measures the proportionate change in national income in response to a change in injections and withdrawals

56
Q

What is the equation for the multiplier ratio ?

A
  • K = change in real output / change in injections

- K = change in Y / change in J

57
Q

What is a positive multiplier ?

A

When an initial increase in an injection (or decrease in withdrawal) leads to a greater final increase in real GDP

58
Q

What is a negative multiplier ?

A

When an initial decrease in injection (or increase in a withdrawal) leads to a greater final decrease in real GDP

59
Q

What is MPC ?

A
  • Marginal propensity to consume

- The proportion of any extra income that is spent on goods and services

60
Q

What is the equation for MPC ?

A

Change in consumption / Change in income

61
Q

Which people are likely to have a higher MPC ?

A
  • People with lower incomes

- When you are struggling to afford the basics, you are likely to spend any extra income you get.

62
Q

What is MPS ?

A
  • Marginal propensity to save

- It is the proportion of any additional income that is saved

63
Q

What is the equation for MPS ?

A

Change in savings / Change in income

64
Q

Which people are likely to have a higher MPS ?

A
  • People with higher incomes

- If you already have what you need, you might choose to save the extra income instead

65
Q

What does MPC and MPS total up to ?

A

MPC + MPS = 1

66
Q

What is MPT ?

A
  • Marginal propensity to tax

- The proportion of any new income that is paid as taxes

67
Q

What is the equation for MPT ?

A

Change in taxation / Change in income

68
Q

What is MPM ?

A
  • Marginal propensity to import

- The proportion of any new income that is spent on imports

69
Q

What is the equation for MPM ?

A

Change in spending on imports / Change in income

70
Q

What is MPW ?

A
  • Marginal propensity to withdraw

- It is the proportion of extra income that is withdrawn from the economy

71
Q

What is its formula ?

A

MPW = MPS + MPT + MPM

72
Q

What is the relation between the multiplier effect and MPW ?

A

The multiplier formula is 1 / MPW

73
Q

What is the effect of a higher multiplier ?

A
  • The higher the multiplier the larger the increase in national income caused by injections will be
  • This is because injections trigger secondary increases in national income
74
Q

What effect does a higher multiplier have on AD ?

A

It causes AD to increase by a larger amount

75
Q

What are the effects of an increase in AD ?

A
  • Higher output (higher economic growth)
  • Higher employment due to an increase in firms need for labour
  • Higher inflation if economy is not in a recession, if the economy is in a recession then there will be no inflation
76
Q

What will happen to the multiplier if MPS increases ?

A

MPW would increase and therefore the multiplier would decrease, because of the equation multiplier = 1 / MPW

77
Q

What will happen to the multiplier if MPT increases ?

A

MPW would increase and therefore the multiplier will decrease, because of the equation multiplier = 1 / MPW

78
Q

What will happen to the multiplier if MPM increases ?

A

MPW would increase and therefore the multiplier will decrease, because of the equation multiplier = 1 / MPW

Economics AS (11 decks)

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