adas Flashcards
circular flow of income
money moves from firms to households and back again in a loop -> circulation of money through an economy
firms -national income-> households
households -consumption-> firms
withdrawals
withdrawal of income from the CFoI
-savings-> financial markets
-taxes-> government
-imports-> foreign sector
effect of withdrawals
decrease in consumption in the domestic economy -> firms produce less output -> less revenue/dd for FoP -> national income falls
injections
introduction of income into the circular flow of income
financial markets -> investment
govt -> government expenditure
foreign sector -> exports
effect of injections
domestic economy experiences an increase in expenditure -> firms will hire more FoP to produce more output -> generating more national income and thus more consumption
aggregate demand
total level of spending for an economy, based on the amount of domestically produced goods and services which all sectors of the economy desire to buy at each general price level
= C + I + G + net export expenditure (X-M)
relationship between general price level and level of real national income = real gdp
inverse relationship as the higher the gpl, the lower the quantity dd of all gns, decreasing the real value of output = real ny
wealth effect
as gpl falls, purchasing power of households will increase, assuming that the nominal income is unchanged as they will be able to use the same income to buy more goods and services. this encourages them to spend more, causing quantity dd of domestically produced gns to increase
interest rate effect
as gpl falls, households need less money to purchase gns -> dd for money fall, with a fixed ss of money -> ir, price of money, falls -> encourages borrowing for consumption on interest sensitive items (new cars, investment) -> dd for consumption and investment increases
international substitution effect
domestic gpl falls while foreign prices remain constant -> domestic gns have become cheaper in comparison to foreign substitutes -> increase dd from both residents and foreigners for domestic gns
induced consumption
dependent on the current level of real NY, which affects households’ ability and willingness to purchase gns
determinants of autonomous consumer expenditure
economic outlook and consumer confidence, expectations of future prices, wealth
-> more willing to spend on gns
interest rates and access to credit
-> opportunity costs of current consumption falls -> increase in borrowing to purchase interest sensitive items
personal income taxes (affects disposable income)
demographic changes, distribution of income (rich tend to spend less of any increase in income compared to the poor)
investment
the act of acquiring new fixed capital assets like buildings, equipment and machineries by firms / accumulation of stocks and inventories by the producer
marginal efficiency of investment theory
there is an inverse relationship between interest rate and investment
MEI is the expected rate of return of an additional unit of investment: weigh the cost of profit against MEI, only invest when MEI >= i/r (rational, profit-driven) and the investment can at least cover the cost of borrowing
determinants of investment expenditure
i/r -> access to credit, MEI yield
business confidence -> increases expectations for investment -> movement of MEI curve
corporate tax rates, technology changes -> increases profitability of investment -> movement of MEI curve
determinants of net exports
national income of trading partners/domestic national income -> dd for exports/imports
relative price levels, exchange rates -> substitution for domestic gns in the country with a higher price level -> more imports for that country (PED)
trade protectionism -> reduced imports
aggregate supply
the total value of output of gns that domestic firms as a whole produce and sell at each gpl
as diagram
keynesian range, perfectly price elastic: abundance of spare capacity, able to increase production without incurring higher costs
intermediate range: rising gpl with rising output as resources become increasingly scarce
classical range, price inelastic: no possible increase in output as resources are fully employed. if ad rises, only gpl rises
non-price determinants of as
efficiency/unit cost of production -> vertical shift of the as curve
quantity/quality of fop (caused by investment) -> productive capacity -> potential economic growth, full employment frontier increases-> horizontal shift of the as curve
effects of a change in AD
disequilibrium
AS > AD
accumulation of inventories -> reduce production in the next time period -> contraction of economy as RNY = money value of all gns produced within the economy
AD > AS
shortage in inventories -> increase production in the next period -> expansion of economy
changes in AD
economy moves closer to full employment, into intermediate range -> competition for scarce FoP, bid up of prices -> GPL increases, and AD falls due to wealth i/r and international substitution effects, eliminating shortage -> economic growth as the equilibrium real ny increases
multiplier effect
initial change in autonomous AD leads to a more than proportionate change in NY, assuming spare capacity
multiplier
a numerical coefficient by which a change in autonomous spending is multiplied to show the final change in equilibrium ny
= change in NY/change in AD
explaining the multiplier
use an example, shift ad curve twice to reflect how firms produce more output to meet rise in AD and pay out more income to households who then spend a proportion on consumption, generating cycles of spending
process does not continue infinitely because of the presence of withdrawal, causing the process to stop when cumulative sum of withdrawals=initial increase
how changes to AD affect the multiplier
1/(1-MPC): direct relationship
1/MPW: indirect relationship
MPS, MPT, MPM
factors which affect the multiplier
government policies, welfare -> MPT
pessimism in economy, cultural differences, CPF -> high MPS
resource constraints, openness of economy -> high MPM
limitations of the multiplier effect
if multiplier is small, rny will not see that much of an increase
if there is insufficient spare capacity (developed economies), the multiplier will be dampened by the increase in GPL as it will cause the level of consumption to decrease and the full effect of the multiplier will not be experienced
time lags
difficult to accurately measure
how macrogoals are achieved
economic growth: increase in rny
unemployment: labour is more effectively used when rny is high
low and stable rate of inflation: increasing productive capacity keeps inflation at bay
favourable balance of trade position
