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✅ Y1 Economics Macro > 3.2.2 Circular Flow Of Income, AD, Supply Analysis, Related Concepts > Flashcards

3.2.2 Circular Flow Of Income, AD, Supply Analysis, Related Concepts Flashcards

1
Q

Define AD

A

Total planned spending on real output produced within the economy

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2
Q

What is the AD equation, and what are each of the components?

A

AD = C + I + G + (X-M)

C = consumption
I = investment by firms
G = government spending
X = exports
M = imports
(X-M) = net exports
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3
Q

What is the difference between national income, national output and national product?

A

There is no difference! Used interchangeably

All describe flow of new output produced by economy in a particular period

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4
Q

Name the 5 key economic agents within an economy (circular flow of income)

A
  1. Households
  2. Firms
  3. Banking sector
  4. Government
  5. Foreign sector
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5
Q

What are the 3 injections into the circular flow of income?

A
  1. Government spending
  2. Investment
  3. Exports
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6
Q

What are the 3 leakages / withdrawals in the circular flow of income?

A
  1. Taxation
  2. Imports
  3. Saving
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7
Q

If injections = withdrawals, then national income will…

A

Remain the same

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8
Q

If injections > withdrawals, then national income will…

A

Rise

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9
Q

If injections < withdrawals, then national income will…

A

Fall

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10
Q

Difference between 1. nominal and 2. real income?

A
  1. Nominal income:
    Income that hasn’t been adjusted for inflation and decreasing purchasing power
  2. Real income:
    Estimation of an individuals actual purchasing power in the open market after accounting for inflation
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11
Q

What is the accelerator theory of investment?

A

It stems from the assumption that firms wish to keep a fixed ration between the output they are currently making and their existing stock of capital.

If national output grows by a constant amount, firms invest in exactly the same amount of new capital each year to maintain the desired capital-output ratio.

If growth accelerates, investment increases

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12
Q

Define nominal income

A

Income that has NOT BEEN ADJUSTED for inflation and decreasing purchasing power

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13
Q

Define real income

A

estimation of an individuals ACTUAL purchasing power in the open market after ACCOUNTING FOR INFLATION

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14
Q

What factors shift AD curves left and right?

A

Leftward shifts:

  • house prices fall
  • consumer confidence falls
  • credit becomes less readily available

Rightward shifts:

  • level of national income rises
  • technological advancements — price of capital falls
  • new tax system — redistribution of wealth
    • an increase in a component of AD equation
  • movement (contraction / extension) on the AD curve is a change in price level
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15
Q

What was the credit crunch, how did banks react to it?

A

Sudden sharp reduction in availability of money or credit from banks and other lenders
Consumption and investment fell, availability of credit fell and cost of borrowing rose. AD FELL

They bailed out or nationalised banks

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16
Q

Define debt bubbles

A

Expansion of debt to an unsustainable level

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17
Q

Define sub-prime borrower

A

An individual, business or country with a less-than-perfect credit rating (high risk debtor)

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18
Q

What is the multiplier effect?

A

Relationship between change in AD and the resulting (usually larger) change in national income.
Injections of demand into the circular flow of income stimulates further rounds of spending, which has a larger impact on local or National income

MULTIPLIER CAN WORK IN REVERSE, reducing national income

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19
Q

Formula for multiplier effect?

A

Change in Y = Change in G x K

Y= national income
G = Gov spending
K = multiplier

K =
1
——————
1 — MPC

K = multiplier
MPC = marginal propensity to consume
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20
Q

What does MPC mean?

A

Marginal Propensity to Consume

How much a consumer changes their spending following a change in income.

The higher the MPC, the larger the size of the multiplier

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21
Q

Define aggregate supply

A

Level of real national output when producers are prepared to supply at different average price levels

(PL and production costs are the main determinants of the short-run AS)

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22
Q

What causes rightward LRAS shifts?

A

Increase in quantity or quality of any of the FOP.

Caused by factors such as:

  • immigration
  • productivity
  • factor mobility
  • economic incentives
  • underlying economic growth is represented by a rightward shift in the long-run AS curve
23
Q

What is an economic shock, and the 2 categories?

A

Unexpected events that hit the economy

2 categories:

  1. Demand side
    - recession
    - house prices rising exponentially
    - credit crunch
  2. Supply side
    - oil / energy prices rising
    - net migration altering dramatically
    - crop shortages / food price rises
24
Q

What is national income?

A

A measure of the monetary value of goods and services manufactured by the residents of the country, in a year

25
Q

What are the determinants of savings?

A
  • rising income
  • interest rates
  • economic growth
  • age of individuals
  • wealth
  • inflation
26
Q

What is the difference between saving and investment?

A
  • Saving money typically means it is available when we need it and it has a low risk of losing value.
  • Investing typically carries a long-term horizon
  • The biggest and most influential difference between saving and investing is risk
27
Q

How does AD influence the level of economic activity?

A
  • employment
    Influences production and consumption
  • confidence
    Influences level of spending and investment
  • events
    Natural disaster or Xmas influences consumer spending
  • other factors
    Taxes or interest rates influence how much people borrow / save / spend
28
Q

What are the fundamental determinants of long-run AS?

A
  • technology
  • productivity
  • attitudes
  • enterprise
  • factor mobility
  • economic incentives
29
Q

What do we use to measure national income?

A
  • real GDP
  • nominal GDP
  • gross national product GNP
  • gross national income GNI
30
Q

Define full employment income

A

The total output of an economy when unemployment is minimised or is at the government target. This accounts for frictional unemployment

31
Q

What is an injection into the circular flow of income?

A

Money which enters the economy

32
Q

What is a withdrawal from the circular flow of income?

A

Outflow of money with leaves the economy

33
Q

What occurs to the economy if there are net injections?

A

Expansion of national output

34
Q

What occurs to the economy if there are net withdrawals?

A

Contraction of production — output decreases

35
Q

What causes short-run AS curves to shift left and right?

A

SRAS shifts when:
- cost of employment might change I.e wages, tax etc
- cost of other inputs I.e raw materials, exchange rate etc
- Gov regulation or intervention I.e environmental laws and taxes etc

36
Q

What is the difference between what SRAS and LRAS curves show?

A

SRAS:
Only covers the period immediately after a change in PL — shows the planned output of an economy when prices change, whilst the costs of other FOP remain constant

LRAS:
Shows the potential supply of an economy in the long run — when prices and costs of productivity, FOP etc can change

37
Q

What does macroeconomic equilibrium look like on a diagram?

A

AD = AS
(Rate of withdrawals = rate of injections)

38
Q

Define disposable income

A

Amount of income consumers have leftover after taxes (spendable)

39
Q

How might a consumer earn income?

A

Via wages, savings, pensions, benefits and investments

40
Q

Define marginal propensity to consume

A

How much a consumer changes their spending following a change in income

41
Q

Define marginal propensity to save

A

Proportion of each additional pound of household income that is used for saving

42
Q

What factors influence consumer spending?

A
  1. Interest rates:
    If MPC lower interest rates, it is cheaper to borrow and it reduces the incentive to save. C increases
    > there are time lags so not suitable if rise in AD is needed immediately
  2. Consumer confidence:
    Higher confidence means more risk taking and investment. C and I increases
    If consumers fear unemployment or high taxes they are likely to save more
43
Q

What factors influence investment?

A
  1. Rate of economic growth:
    If growth is high, firms will make more revenue due to increased C
  2. Business expectations and confidence:
    If firms expect a high rate of return, I increases. If Gov changes happen or commodity prices rise, businesses may postpone their investment decisions
  3. Demand for exports:
    Higher demand mean higher I (higher expected sales)
  4. Interest rates:
    I increases as interest rates fall (cost of borrowing becomes less) vice versa
  5. Access to credit:
    If banks are unwilling to lend, it will be harder for firms to invest unless they use retained profits. It is dependant on the level of savings in the economy — higher consumer saving means more available funds for lending
  6. Gov regulations
    Rate of corp tax could affect investment — lower taxes mean more profits for firms which could encourage investment
44
Q

What is Gov spending?

A

How much the government spends on state goods and services I.e healthcare

45
Q

What factors influence government expenditure?

A
  1. Trade Cycle;
    boom and bust cycles: recession / bust means less spending, recovery and boom stages mean more output / spending
  2. Fiscal Policy;
    Spending on fiscal and merit goods (demand side policy) influences composition of AD
  3. Exports minus imports;
    Net imports: surplus means more exports which allows for more Gov expenditure whereas deficit means more imports
46
Q

What are the main influences on the (net) trade balances;

A
  • real income
  • exchange rates
  • state of the world economy
  • degree of protectionism
  • non-price factors
47
Q

What is the multiplier ratio

A

The ratio of the rise National income to the initial rise in AD

48
Q

Would SRAS being elastic or inelastic mean the multiplier effect is likely to be smaller than it’s potential?

A

SRAS being inelastic,
As if AD increases, prices will increase rather than a full increase in national income, leading to higher inflation and higher interest rates (encourages saving)

49
Q

What does MPS mean?

A

Marginal Propensity to Save

If consumers save more than they spend, the size of the multiplier will be small

50
Q

Why would LRAS be vertical (classical economics)?

A

Because output is fixed at each level, all FOP in the economy are fully employed in the long run (only changes price level not RNO)
The position of LRAS represents the normal capacity level of output of the economy

51
Q

What does the Keynesian AS curve suggest (horizontal and vertical sections)

A

That the price level in an economy is fixed until resources are fully employed. The horizontal section shows the output and price level when resources are not fully employed; there is spare capacity within the economy. The vertical section is where all resources are fully employed.

52
Q

What are the rough stages of a boom and bust cycle?

A

An economy goes through boom and bust cycles:
- RNO increases when there is a growth AKA recovery stage
- the boom is when growth is fast (could be inflationary)
- during recession, output falls and there is -ve growth. Governments spend to stimulate, provide welfare etc
- during booms governments will earn more revenue through taxes from people spending

53
Q

How does globalisation contribute towards structural unemployment?

A

Production in the secondary sector i.e clothing offshore / outsource to cheaper countries causing domestic unemployment

54
Q

How does migration contribute towards structural unemployment?

A
  • migration out of a region can lead to a worker shortage
  • migration into a region can lead to oversupply of workers in certain industries
  • migration can lead to mismatch between the skills of workers and the needs of employers

✅ Y1 Economics Macro (4 decks)

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