6 Macroeconomic Context of Business I

Question 1

What are the four main objectives of a government?

Answer 1

1. Inflation
2. Employment
3. Balance of Payments
4. Growth
   Also:
   - Redistribution of wealth in favour of the poor
   - To protect the environment

Question 2

What is meant by ‘full employment’?

Answer 2

• Anyone who wants a job but doesn’t have on will only be out of work for a short period of time. At any given time there are only low levels of unemployment.

Question 3

What is the goal of price stability?

Answer 3

• Inflation = sustained rise in general price levels.
• Measured as annual rate of change of the RPI (headline rate of inflation)
• For prices to be stable => inflation rate = 0
• Govt prefer to target underlying rate of inflation - annual % change in RPIX

Question 4

How do govts achieve high (but sustainable) economic growth?

Answer 4

• Measured in terms of real GDP
• ‘Real’ means effects of inflation been removed
• GDP = measure of annual output of economy
• GNP = Gross National Product (similar to GDP)

Question 5

What tools do govt’s have to achieve their goals?

Answer 5

• Demand-side policies
  => aim to influence AD, main components =
  a) fiscal policy (govt spending & taxation
  b) monetary (Supply of money, int rates, XR’s and availability of credit
• Supply-side policies
  => influence supply within economy by promoting competition, reducing trade union power & use of tax incentives

Question 6

What are the 4 factors of production?

Answer 6

1. Land
2. Labour
3. Capital
4. Entrepreneurship

Question 7

What is the equation for expenditure?

Answer 7

E = C + I + F + (X - M) =>

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

Question 8

What are the withdrawals in the circular flow of income?

Answer 8

1. Savings
2. Taxation
3. Imports

Question 9

What are the injections into the circular flow of income?

Answer 9

1. Investment
2. Govt Spending
3. Exports

Question 10

What happens if there is an imbalance between injections/withdrawals?

Answer 10

1. If injections > withdrawals (e.g. drop in interest rates => to greater levels of investment) => more coming in to the circular flow of income than going out => period of growth
2. If withdrawals < injections (e.g. rise in interest rates => increased level of savings) - slowdown in the economy

Question 11

What are the three methods for measuring national income?

Answer 11

1. The output method
2. The expenditure method
3. The income method

Question 12

What does GDP measure?

Answer 12

• Includes output of foreign-owned firms in the UK but excludes value of output produced by UK firms located overseas.
  = Gross Value Added. Also shows:
  1. Extent of economic growth
  2. Changes in living standards
  3. Comparison of econ performance and living standards between countries
  4. Judge performance of different sectors of economy

Question 13

What does GNP measure?

Answer 13

Measures the output from assets belonging to the country’s popln and includes earnings from investments abroad.

Question 14

What is the multiplier effect?

Answer 14

• This theory suggests can stimulate an economy with a relatively small increase in spending.
• An initial injection (govt spend) => further rounds of spending.

Question 15

What are the two different types of Consumption that can make up the AD?

Answer 15

1. Autonomous consumption = this is consumption that is not income dependent. Even if you didn’t earn money, you would still consume.
   - Rely on savings, welfare payments and borrowing
2. Income induced consumption = this is consumption that increases your level of income.
   - Driven by your MPC = proportion of additional income that is spent on consuming goods.

Question 16

How do you calculate the average propensity to consume?

Answer 16

Total consumption/ (divided by) Income

Question 17

How can the overall consumption function be represented?

Answer 17

C = a + bY

a = autonomous consumption
b = MPC
Y = Income level

Question 18

What is the multiplier formula?

Answer 18

Final change in national income/ Initial change in aggregate demand

For an economy to be in equilibrium it means that planned expenditure needs to be equal to national income

Question 19

How can we quickly calculate the value of the multiplier in a simple closed economy?

Answer 19

Multiplier = 1 / 1 - MPC or 1/ MPS

(closed economy)

MPC + MPS = 1

Question 20

How can we quickly calculate the value of the multiplier in a open economy?

Answer 20

• Have to take into account govt spending, tax, imports and exports & the following withdrawals:

MPT - marginal propensity to tax
MPM - marginal propensity to import

Multiplier = 1/ 1 - MPC or 1/ MPS + MPM + MPT (MPW)

MPC + MPS + MPT + MPM = 1

Question 21

How can a multiplier be shown on a graph?

Answer 21

(look at page 74)

Initial injection => causes AD line to move from AD1 to AD2 => increase in Y of $400m

Question 22

What is the accelerator principle?

Answer 22

When consumer export or demand rising strongly => increased business investment to expand production and meet demand. = Accelerator effect

Question 23

What are the two categories that capital investment can be split into?

Answer 23

1. Replacement Investment - replacing capital items as they become old and reach the end of their useful lives. Productive capacity remains unchanged.
2. Net investment - investment which => increase in productive capacity (above replacement capacity)

Question 24

What does the marginal efficiency of capital (MEC) represent?

Answer 24

The % return the each additional unit of capital generates (IRR).
- If its > than interest rate => profitable return.
- Keynes concept suggests that overall relationship between short-term interest rate and amount of investment was inelastic.
- Level of investment is dependent on long-term expected interest rates
- Investment vs Interest Rates => inverse relationship (graph on pg 75)
=> MEC curve could shift outwards due to:
a) New technology increasing productivity
b) More expensive direct labour => attractive to automate production

Overall, short-term interest rates do not have a large impact on investment decisions => innovations.

Question 25

What are the 4 stages of the economic cycle?

Answer 25

1. Recession = two consecutive periods of a reduction in the rate of growth of an economy
2. Boom = Growth above a long term sustainable level
3. Recovery = initial increase in spending => greater increase in NI
4. Depression = slowdown of initial investment => reduction in investment => downward effect of multiplier exaggerates the ultimate change in national income => depression

Question 26

What happens in a boom?

Answer 26

1. Business produce more goods & invest in more machinery - unemployment reduces
2. Consumers spend more money
3. Less money is spent by the govt on unemployment benefits
4. More money is collected by govt in income tax and VAT
5. Prices tend to increase (inflation) due to extra demand
6. Increased demand for goods from overseas => trade deficits

Question 27

What happens in a recession?

Answer 27

1. Businesses cut back on production - some go insolvent
2. Consumers spend less money
3. Individuals may lose their jobs (unemployment increases)
4. More money spent by govt on unemployment benefits
5. Less money is collected by govt in income tax and VAT
6. Prices start to fall
7. Reduced trade deficit

Question 28

What policies are likely to be adopted during a boom phase?

Answer 28

1. Raising taxes (fiscal)
2. Reduce govt spending (fiscal)
3. Raising interest rates (monetary)

(opposite for a recessionary period)

Question 29

What policies do developed economies use that will help reduce the extreme swings in the trade cycle?

Answer 29

1. During a recessionary phase where unemployment is increasing - welfare benefits help ensure minimum spending can be maintained.
2. During boom phase when more workers are employed, progressive tax system (increased % tax rate for high earners) increases the proportion of workers’ income that gets withdrawn from the circular flow.

= AUTOMATIC STABILISERS

Question 30

How is the rate of unemployment calculated?

Answer 30

Number of unemployed/ Total Workforce x 100%

Total workforce = ppl willing and able to work

Always certain level of unemployment = natural rate of unemployment

Question 31

What are the main type of unemployment?

Answer 31

1. Real wage unemployment
2. Demand deficient unemployment
3. Frictional unemployment
4. Structural unemployment
5. Seasonal unemployment
6. Hidden unemployment

Question 32

What is real wage (classical) unemployment?

Answer 32

• This = form of dis-equilibrium unemployment which occurs when real wages for jobs are forced above the market clearing level.
• Trade unions & wage councils are the ones which cause this type of unemployment seen as causing this type of unemployment.
• Classical unemployment result of real wages above market clearing level => excess supply of labour (look at graph on page 78)
• Some economists say introducing national minimum wage => some classical unemployment in industries where the average wage rates are closer to the NMW level & international comp from low-labour cost producers is severe.

Question 33

What is demand deficient unemployment?

Answer 33

= involuntary unemployment due to lack of AD
- Keynesian “demand-deficient” unemployment => transition of economy through the business cycle.
- Where an economic recession, expect to see a rising level of unemployment because of plant closures & worker lay-offs.
- Fall in AD => contraction in output across many industries
- Can exist in long-run when economy constantly running below capacity.
(look at graph on page 79)
- The distance between P1 and P2 = DEFLATIONARY GAP

Question 34

What is frictional unemployment?

Answer 34

= transitional unemployment due to ppl moving between jobs.

• E.g. newly redundant workers entering the labour market may take time to find appropriate job at wage rates they’re prepared to accept.
• Imperfect information => frictional unemployment worse if those unemployed are unaware of employment opportunities
• Sometimes there are disincentives for the unemployed not to accept work

Question 35

What is structural unemployment?

Answer 35

This is when ppl are made unemployed due to capital-labour substitution or long-run decline in an industry.
- Mismatch between skills and requirements of new job opps.
=> sometimes known as technological unemployment
- Many unemployed form heavy manufacturing industry have found it difficult to gain re-employment without re-training.
= OCCUPTATIONAL IMMOBILITY

Question 36

What is seasonal unemployment?

Answer 36

Demand for workers varies depending on what time of year it is in some industries. e.g. tourism

Question 37

What is hidden unemployment?

Answer 37

• Ppl who are interested in taking paid work but for one reason are not classified as unemployed.
• E.g. discouraged workers => ppl who have given up active search for a job as they have been out of work for a long time => lose motivation and skills.
• Poverty trap = jobless workers may not apply for jobs because of financial disincentives created by income tax & state benefits system.

Question 38

What are the consequences of unemployment?

Answer 38

1. Greater need for benefits and welfare payments
2. Increased crime
3. Creates a greater divide between those that ‘have’ and those that ‘have not’
4. Lost workplace skills
5. Slowdown in economic output