3: The Macroeconomic enviroment

Question 1

What are the different measures of National Income?

Answer 1

GDP: Value of goods and services produced WITHIN an economy.

GNP: GDP + Net property income.

National Income: GNP - Depreciation

Question 2

Problems with the assumption that increase in National Income is a measure of increase in living standards?

Answer 2

Not all valuable goods are bought at market value.

No distinction between consumer and capital goods.

Economic growth may be caused by population increases & not measure environments & living standards impact.

Could be due to inflation.

Question 3

What is full employment national income? Why is it caused? And what happens after it?

Answer 3

When Aggregate supply becomes vertical and cannot increase any further. This is due to the country using all of its resources and being unable to supply further.

Any further increases in demand will lead to inflation.

Question 4

What are the injections vs withdrawals within the Circular flow of income?

Answer 4

Injections: Investments, Government spending, Exports.

Withdrawals: Savings, Taxation, Imports.

Question 5

What stimulates aggregate demand?

Answer 5

Injections.

Question 6

How to calculate change in national income using the Multiplier?

Answer 6

1/(1-MPC) x Injection.

Question 7

What factors can affect levels of exports?

Answer 7

Competitiveness of domestic industries.

Income in foreign countries.

Rate of economic growth in foreign countries.

Exchange rates.

Question 8

What stimulates aggregate supply?

Answer 8

Increased injections in technology & capex, or incentives for firms to employ workers. (supply-side policies)

Question 9

Demand management vs Supply side polices: Which leads to price rises/falls.

Answer 9

Demand Management leads to increased prices (Inflation) (causes shortages which leads to price rises)

Supply side policies lead to price falls. (Causes surplus’s which leads to reduction in prices)

Question 10

How do we calculate consumer spending?

Answer 10

C = A + BY

A = Autonomous consumption (Consumption regardless of income)
B = Marginal Propensity to Consume. (Proportion of income people will spend on consumption)
Y = National Income.

Question 11

How to calculate national income?

Answer 11

Consumption + Injections = Income.

Question 12

How to calculate National Income (Y) with given consumption equation & Injections?

Answer 12

Step 1: Expand ( A + MPC * Y) + Injections = Y
Step 2: Add Autonomous Spending & Injections & bring (MPCY) to the other side of equation.
A + Injections = Y - (MPCY)
Step 3: Simplify equation: A+Injections = ((1-MPC)*Y))
Step 4: Solve for Y: A+Injections / (1-MPC) = Y

Question 13

What are the economic objectives of society?

Answer 13

Economic growth: Increases in National Income per head.
Low inflation
Low unemployment
Balance between exports and imports (Balance of trade): Imbalance puts pressure on currency.

Question 14

What are the problems of high inflation?

Answer 14

Interference with price mechanism: Rising prices from inflation rather than high demand.

Redistrubution of income & wealth: Borrows gain as value of repayments fall, Savers suffer as purchasing power is reduced.

Adverse impact on balance of payments: Exports become relatively more expensive while imports become cheaper.

Question 15

3 tools to help governments achieve economic objectives?

Answer 15

Fiscal policy: Government spending & Taxation.

Monetary policy: Interest & Exchange rates & money supply.

Supply side policies: Capex.

Question 16

Responses to trade cycle?

Answer 16

Boom: Reduced spending (Budget surplus), Increased taxation, increased interest rates.

Downward phases: Increased spending (Budget deficit), Tax cuts, Reduced interest rates.

Question 17

What are inflationary / deflationary gaps?

Answer 17

Inflationary: Where level of planned AD is above level needed to assure full employment.

Deflationary: Level of AD is below the level needed to assure full employment.

Question 18

What are the causes of inflation?

Answer 18

Demand pull inflation: Inflationary gaps.

Cost push: When cost of production increases even though they are not in short supply. (Can be caused by trade unions & Import costs)

Expectations of inflation can actually bring inflation. (Increased wage demands)

Supply of money: The general price level of goods and services is proportional to the money supply in an economy

Question 19

What could be observed when a countries rate of economic growth slows?

Answer 19

An increase in inventory levels: As demand begins to drop, more goods will be held as inventory.

Question 20

What is likely to occur at a depression phase of the trade cycle?

Answer 20

An economy will be stuck at low levels of national income, giving rise to a deflationary gap.

Question 21

What is stagflation?

Answer 21

When economic growth is low/negative and inflation is high.

Question 22

How to calculate index numbers fixed & chain base?

Answer 22

Fixed = New year / Original year.

Chain base = New year / Last year

Question 23

How to calculate a deflated base amount? & % change between two?

Answer 23

Current value x (Base index number / Current index number)

(Delated value - Original value) / original value = % Change.

Question 24

Differences between base weighted index vs current weighted index?

Answer 24

Base uses base quantities and varying prices.

Current uses current quantities and varying prices.

Question 25

How to calculate overall price index?

Answer 25

(Weight/Base x Index) repeat for all items and sum to give overall total.

Question 26

How to calculate price index if hypothetically a change in base year had not happened?

Answer 26

(New base / 100) x (New value / 100)

Question 27

What are the types of taxes?

Answer 27

Direct: Income tax (Progressive/Proportional)
Indirect: VAT (Regressive)

Question 28

What are the types of government deficit? (Government spending > Tax Receipts)

Answer 28

Cyclical: As a consequence of the Trade Cycle.

Structural: Long term, not associated with the Trade Cycle.

Question 29

What are policies to deal with structural deficits?

Answer 29

Emergency loans - from other National governments or from international institutions at low interest rates to financial the present deficit.

Austerity measures - Cut public spending, increase taxation. (But this reduces aggregate demand and cause recession)

Sale of state assets. (Privatisation)

Question 30

What are the types of Fiscal Policy?

Answer 30

Expansionary fiscal stance: Spending > Taxation. (Increasing national debt, used in a recession to boost AD & reduce deflationary gap.)

Contractionary fiscal stance: Taxation > Spending. (Decreasing National debt, used to decrease AD & Demand pull inflation in boom periods.)

Question 31

What is monetary policy? And benefits/drawbacks of increasing money supply?

Answer 31

Concerned with the quantity and value of money in the economy (How money supply and interest rates influence AD)

Benefits:

Lower interest rates
Higher consumer spending
Higher lending to businesses to finance investment
Higher share prices

Drawbacks: Can increase inflation.

Question 32

What are the impacts of an increase in interest rates?

Answer 32

Spending falls: Cost of credit increases (More desire to hold money than to spend)

Investment falls: Rates make borrowing more expensive, so opportunity cost rises and NPV of investments fall.

Foreign funds attracted: Interest rates are the reward for capital so increase in rates attracts foreign investors.

Rise in exchange rates: Inflow of foreign funds increases demand for currency, increasing the exchange rate.

Inflation rate falls: The overall goal of a rate rise: Reduction in spending reduces AD, having a deflationary impact on the economy.

Question 33

Why do supply side economists believe AS is more important than AD?

Answer 33

An increase in productive capacity permits a non-inflationary expansion of AS. Causing increased employment which generates extra demand, and the economy remains in equilibrium.

Question 34

What are supply side policy measures?

Answer 34

Increased competition through deregulation and privatisation of state-owned industries.

Reduction in direct taxes in order to increase incentives to invest and work.

Improve labour effectiveness and flexibility in the labour market by reducing the power of unions. Encouraging recruitment through relaxed minimum wages.

Improved skills through the provision of training.