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Econ AS > 2.4 > Flashcards

2.4 Flashcards

1
Q

intro to circular flow:

A
  1. households receive incomes and buy goods and services
  2. business hire factors of production
  3. government collect taxes and use it for government spending
  4. uk buys imports from other countries, and consumers buy uk exports
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2
Q

what do households do in the circular flow of income?

A
  • save money (leakage), but with financial sector, money can be used for business investment to firms
  • purchase goods and services, flow to firms(consumer spending)
  • pay taxes to government (leakage)
  • provide factors of production
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3
Q

what do governments do in the circular flow of income?

A
  • social transfers to households ( G spending)
  • govt purchases from firms
  • receive taxes and reinvest
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4
Q

what do firms do in the circular flow of income?

A
  • pay incomes to households
  • pay taxes to government
  • control market demand and supply
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5
Q

different measures of income

A

o Original income = Income from jobs, private pensions & interest from savings. o Gross income = original income + cash (welfare) benefits.
o Disposable income = gross income - direct taxes.
o Post-tax income = disposable income - indirect taxes.

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6
Q

gini coefficient as a measure of income inequality

A

commonly used measure, value between 0 and 1, higher the number, greater the inequality

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7
Q

other measures of income inequality

A

• Palma Ratio: Ratio of the income of richest ten percent of households to the income of the poorest forty percent
of households.
• S80/S20 ratio – this is the ratio of the total income received by the richest and poorest 20% of people.
• P90/P10 ratio – this is calculated as the ratio of incomes of the person at the 90th percentile and the person at
the 10th percentile.

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8
Q

what are the 3 injections within an open economy?

A

o Investment spending on new capital goods (I)
o Exports of goods and services (X)
o Government spending on public services (G)

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9
Q

what are the 3 leakages within an open economy?

A 
o Savings (S)
o Imports of goods and services (M) 
o Taxation (T)
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10
Q

changes in net injections and leakages

A

when inj=with, ie. I+G+X = S+M+T = equilibrium national income
if IGX higher national income will rise

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11
Q

When drawing extended AD/AS diagrams make sure that you

A
  • Label the axes accurately as Price Level (y-axis) and Real GDP (x-axis)
  • Label the AD and AS curves
  • Indicate the macroeconomic equilibrium price level (P) and level of real GDP (Y)
  • Carefully label any shifts in AD/AS and their associated new equilibrium points (this is really important!)
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12
Q

Short run equilibrium

A

• Equilibrium is established when AD intersects with AS (i.e. planned output and demand are in balance).
• What matters is whether total planned demand for goods and services (AD) is close to actual production from
domestic and external sources.

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13
Q

Impact of an Increase in Aggregate Demand

A
  • An increase in AD causes an expansion of aggregate supply and a higher equilibrium level of national output.
  • An outward shift of aggregate demand will bring about a cyclical rise in output and employment.
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14
Q

Impact of a Fall in Aggregate Demand

A

A decrease (inward shift) in AD causes a contraction of AS and a lower equilibrium level of national output.

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15
Q

Impact of an increase in Aggregate Supply

A

• An increase in AS causes an expansion of AD and a higher equilibrium level of national output.
• An outward shift of aggregate supply e.g. caused by lower unit costs should help to increase business profits.
- a,so decreases the general price level

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16
Q

Impact of a fall in Aggregate Supply

A
  • A decrease in AS causes a contraction of AD and a lower equilibrium level of national output.
  • An inward shift of aggregate supply e.g. caused by a rise in unit costs will lead to lower business profits.
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17
Q

Causes of Fall (Inward shift) in AS

A
  • Brain drain – an outward migration of skilled workers
  • Production shut-downs due to a pandemic / health crisis
  • Higher costs from higher global commodity prices
  • Effects of natural disaster / political conflict / civil war
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18
Q

Possible Macro Consequences of inward shift of AS

A
  • May cause higher inflation if potential supply falls
  • may reduce real gdp growth
  • may lead to lower profits, investment and employment
  • may worsen the trade balance if export sectors are hit
19
Q

Formula for multiplier (closed economy with no government)

A

Multiplier = 1 / (marginal propensity to save) Multiplier = 1 / (1-marginal propensity to consume)
eg, if MPC = 0.9, and gov increases spending by 50000 multiplier = 1/0.1 = 10
10 x 50000 = £500000 added to circular income

20
Q

Formula for multiplier (a closed economy with a government sector)

A

o The calculation for the value of the multiplier is:

o Multiplier = 1 / (sum of the marginal propensity to save + marginal rate of tax)

21
Q

Formula for multiplier (an open economy with a government sector)

A

o An open economy engages in international trade of goods and services with other countries o The calculation for the value of the multiplier is:
 Multiplier = 1 / (sum of the propensities to save + tax + import)

22
Q

Positive multiplier effect:

A

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

23
Q

Negative multiplier effect:

A

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

24
Q

MPC =

A

change in consumption following a change in income
 i.e. change in total consumption / change in gross income
depends on factors that affect consumption

25
Q

MPS =

A

change in total savings / change in gross income

26
Q

High multiplier value when

A
  • Economy has plenty of spare capacity (i.e. a negative output gap) to meet higher aggregate demand
  • Marginal propensity to import and tax is low (important leakages)
  • low marginal propensity to save
27
Q

Low multiplier value when

A
  • Economy is close to it’s capacity limits e.g. during a boom phase of the economic cycle
  • Propensity to import goods & services is high – this means extra demand leaks from circular flow
  • Higher inflation causes rising interest rates which then dampens the other components of AD
28
Q

2 sector economy circular flow of economy

A

Households hold wealth and provide resources

  • are paid for factors of production
  • money then used to buy firms goods
29
Q

What do both Keynesian and classical economists agree on?

A
  • In short term, AD will be downward sloping and AS is upward sloping
  • also that there is full employment when LRAS is vertical
30
Q

Describe the classical LRAS curve

A
  • classical LRAS is perfectly inelastic
  • shift in AD would only affect the price level, not national output
  • classical economists believe that the economy will always return to this point
31
Q

What is the classical economist theory when AD shifts

A
  • classical believe that as AD1 shifts out to AD2 = positive output gap
  • economy now in long term disequilibrium as SRAS1 and AD2 don’t intersect on the LRAS curve
  • short term equilibrium is p2y2 (where AD2 and SRAS1 meet), so there is over full employment, and firms will bid up wages of labour to attract best workers
  • costs of production increase, so SRAS1 shifts inwards to SRAS2
  • eventually, economy will produce on the LRAS at same output but higher prices
32
Q

Conclusions classical economics and ~AS/AD

A
  • Increase in AD will increase price and output in the short term, but over time prices will continue to rise as economy moves back to the LRAS
  • ONLY way to increase output in the long run is to increase LRAS
33
Q

What happens when LRAS shifts out

A
  • lower prices and higher output at p2y2 than p1y1
  • although there is short term disequilibrium, SRAS will close this gap soon
  • as a result, classical economists believe in supply side policies to boost a nations economy
34
Q

3 zones on a Keynesian LRAS curve called

A
  • Keynesian zone
  • intermediate zone
  • neoclassical zone
35
Q

Keynesian economists believe that

A
  • in times of recession, there is lot of spare capacity, so LRAS curve is elastic and increase in AD can be met with increased output without a change in price (Keynesian zone)
  • as economy reaches full capacity, LRAS becomes more and more inelastic, meaning increases in AD will soon only increase inflationary pressures and have no effect on output
36
Q

Impact of shift in Keynesian LRAS depends on

A

Elasticity if curve:

  1. Recession - ie, shift in LRAS will not affect output
  2. Boom/ recovery - outward shift in LRAS decrease prices and increase output

Keynes is trying to say that even if you shift LRAS during times of recession, it will not change output as AD will remain the same, as a result he argues that during recessions governments should look to employ demand side policies

37
Q

What is the multiplier effect

A

Idea that increase in AD due to increased injections can lead to a further increase in national income

38
Q

size of multiplier will be determined by:

A

how much of an increase in income people will spend (MPC)

- lower the leakages = higher the MPC = higher multiplier effect

39
Q

why is the concept of the multiplier effect able to work?

A

due to the concept of circular flow of income - one persons spending is another income

40
Q

can negative multiplier effect also occur?

A

yes: withdrawal from economy, could lead to an even further fall in income, decreasing economic growth and possibly leading to a decline in the economy.

41
Q

government will target specific groups to increase multiplier,

A

ie. people with higher MPC

42
Q

MPT =

A

change in total taxation following an increase in income

43
Q

MPM =

A

changes in total imports following an increase in income

44
Q

MPW =

A

changes in total withdrawals following an increase in income

MPW = MPS+MPT+MPM

Econ AS (16 decks)

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