AS macro notes Flashcards
What is the equation for Aggregate Demand (AD)?
AD = C + I + G + (X-M
Describe the Wealth Effect in relation to Aggregate Demand
When prices increase then current assets cost less causing a decrease in wealth leading to a decrease in consumption
What factors can cause a shift in the Consumption component of Aggregate Demand?
Decrease income taxes, Increase in stock prices or house prices, Lower interest rates (especially mortgages), New Tecg
What factors can cause a shift in the Investment component of Aggregate Demand?
Decrease corp tax, Decrease interest rate, Increase in demand / constant econ growth (accelerator)
What factor can cause a shift in the Government Spending component of Aggregate Demand?
SSP
What factor can cause a shift in the Net Exports component of Aggregate Demand?
Depreciation / Devaluation of exchange rate
Define Short-Run Aggregate Supply (SRAS)
Short run = period of time when at least one FOP is fixed
Define Long-Run Aggregate Supply (LRAS).
Long run = all FOP vary
What factors can cause a shift in Short-Run Aggregate Supply (SRAS)?
Wage rates, Price of raw materials, Taxes, Productivity, Exchange rate (Appreciation will cause cheaper import prices)
What factors can cause a shift in Long-Run Aggregate Supply
Corporation Tax, Education, Healthcare and Infrastructure (SSP), Competition Policy
Define the Accelerator Effect.
Demand for good increases → shifting AD. Firms may respond initially by using the existing productive capacity. If they expect high demand will be sustained → they may increase spending on FOPs to expand supply capacity. This causes an accelerator effect – where an increase in AD may stimulate another boost in AD due to an increase in investment
Give examples of the Accelerator Effect.
Investment in 4G or 5G networks, Investment in renewable energy as the demand is on the rise
Explain the Multiplier Effect
ultiplier effect shows impact on AD + income due to change in injection.
What factors can change the Marginal Propensity to Consume (MPC) and the Marginal Propensity to Withdraw
Interest rates, Wealth effect, Taxes, Technological Improvements abroad or domestically
What are the benefits of economic growth for consumers?
Economic growth → rising incomes → ↑ in SoL as you can buy / import more goods (especially for LEDC’s)
What are the benefits of economic growth for the government?
↑ Incomes → w/ progressive tax more people are put into higher tax bracket → ↑ Gov tax revenue → + decreased welfare payments. This revenue and decreased welfare payments can be used for SSP + decrease inequality
What are some criticisms or paradoxes related to the benefits of economic growth for consumers?
Karl Marx says most economic benefits go to rich and average household have little gain. Easterlin Paradox states that once basic needs are met an increase in consumption of material goods make no difference to well being / has little impact on marginal utility
What are the limitations to the benefits of economic growth for the government?(evaluation)
Depends if governance is good as if gov is corrupt tax will not be redistributed. With so much debt government may just use these taxes to pay of debt interest instead of redistributing it
What are the benefits of increased economic growth for firms?
Increased economic growth → increased demand → accelerator effect is sustained → decreased COP in the LR → + increased innovation levels
Give examples of Supply-Side shocks.
Commodity price changes e.g. Oil, Sudden wage increases e.g. minimum wage introduced, COVID
Give examples of Demand-Side shocks
GFC, SSS like oil prices ↑ → inflation → high-interest rate → ↓ Demand → Paul Volcker, COVID
Characteristics of a Boom phase in the economic cycle.
Low unemployment → Firms employ more workers, High investment → due to accelerator effect, ↑ Inflation rate / CPI → AD shift right, ↑ in real GDP → AD shift right, Positive output gap
Describe the characteristics of a Downturn/Recession phase in the economic cycle.
High unemployment → firms are laying off workers e.g. 2022, Low investment → need to stay liquid, ↓ Inflation rate / CPI → decrease in AD eases demand pull pressure, ↓ Real GDP → Decrease AD, Negative output gap
Define the Claimant Count as a measure of unemployment.
Measures unemployment by counting the number of people claiming benefits for being unemployed
Define Cyclical Unemployment.
Unemployment that occurs as a result of fluctuations in the business cycle
What are the causes of Cyclical Unemployment?
Lack of demand / AD for workers as businesses are selling fewer goods → firms need fewer workers + need to stay liquid
What is the solution to Cyclical Unemployment?
↑ AD
Define Structural Unemployment.
A mismatch of skills between unemployed workers and the requirements of the job market
What are the types/causes of Structural Unemployment?
Regional structural unemployment (Lack of mobility of labour), Sectoral/Occupational structural unemployment (Skills are no longer needed / unable to adapt to changes in labour demand), Technological structural unemployment (Put out of work due to technology e.g. Dominos factory or airpor
What is the solution to Structural Unemployment?
Workers need re-training or re-allocation
Define Frictional Unemployment.
Unemployment is when workers are in the process of moving from one job to another
What is the cause of Frictional Unemployment?
Takes time for workers to search for and find new jobs
What is the solution to Frictional Unemployment?
Better job information availability via newspapers or job centres or contract regulation
Define Seasonal Unemployment.
Unemployment occurs regularly due to a change in demand for labour in certain industries or occupations that are affected by seasonal factors, such as weather, holidays, or crop cycles
What are the solutions to Seasonal Unemployment?
Provide training and support programs, Job-sharing arrangements
How do demand-side factors affect unemployment?
As AD ↑ (by increasing consumer spending)→ businesses more likely to invest in new capital + expand operations → more workers hired → ↓ unemployment. AD ↓ → cut spending → reduce operations (stay liquid) → layoffs. AD ↑ (by gov spending) → G ↑ → ↑ demand for goods → ↑ employment
How do supply-side factors affect unemployment?
↑ Productivity + ↑ Education levels → workers more valuable → ↑ employment. Labour market participation → ↑ S of workers → downward pressure on unemployment
Define Real Wage Unemployment.
When wages are set above the equilibrium level causing an excess supply of labour which leads to unemployment
What factors can cause Real Wage Unemployment?
Minimum wage laws (The minimum wage set higher than the equilibrium wage rate), Labour unions (Can negotiate higher wages for their members), Efficiency wages (If efficiency wages do not work out then an increase in wages may cause too many job openings for jobs available)
Define Natural Unemployment or the Non-Accelerating Inflation Rate of Unemployment (NAIRU).
Unemployment in the economy when the labour market is in equilibrium
What is the cause of Natural Unemployment?
Natural unemployment arises from structural and frictional factors which is unavoidable in every economy
What factors can affect the Natural Unemployment Rate (NAIRU)?
Labour market flexibility, Re-training programs, Technological change, Education levels and skills
What are the consequences of unemployment for individuals?
Financial hardship → Loss of income → not enough money to pay mortgage → debt spiral → bad credit score, Reduced standard of living → Consumers cut back on spending, Difficulty in finding new employment → Trouble updating skills or getting back into the workforce
What are the consequences of unemployment for firms?
Employment may mean that firms will need to cut back on expansion of the business or may need to de-scale. This can lead to some firms losing out on the EoS that they previously had, causing them to lose their competitive advantage
What is the impact of unemployment on economic output?
Reduced economic output → ↓ productive capacity
What is the impact of unemployment on consumer spending and AD?
Reduced consumer spending → ↓ AD → rGDP
What is the impact of unemployment on government spending and debt?
Increased gov spending → ↑ spending on social welfare → higher government debt (£2400 bn national debt → 95% of GDP)
What is the impact of unemployment on business confidence and investment?
↓ Business confidence/investment → firms less likely to invest in FOP’s and expand operations
Define Demand-Pull Inflation.
This occurs when there is an increase in AD causing AD to shift to the right. This type of inflation occurs when an economy’s demand for goods and services increases faster than the supply can keep up
Explain the chain of reasoning behind Demand-Pull Inflation.
Results in an overall rise in prices as businesses try to maximize their profits by increasing prices. As prices increase, consumers may try to buy more goods and services before prices go up further, creating a cycle of rising demand and rising prices
Define Cost-Push Inflation.
This occurs when there is an increase in COP to firms
Explain the chain of reasoning behind Cost-Push Inflation
As COP ↑, to maintain profitability firms will need to ↑ prices and rely COP ↑ to consumers → inflation + regressive
What is the equation for the Quantity Theory of Money?
MV = PQ (M = money supply, V = velocity, P = price of goods/inflation, Q = national output)
According to Monetarists, how are Q and V viewed in the short run?
Monetarists believe that in the SR Q and V are fixed because V is primarily driven by long-term factors such as a change in financial institutions, technology and population growth
According to Monetarists, how is Q viewed in the long run?
Q is relatively fixed in the long run as potential output is normally driven by FOP’s such as labour capital and technology which is relatively stable over time
What are the costs of high inflation in terms of economic growth and unemployment?
High inflation → ↑ unpredictability for firms + consumers → difficult for firms to plan for the future. High inflation = ↑ interest rates → firms reduce investment as they need to pay off debt and cut cost → Huge unemployment increase e.g. Google layoff 12,000 + Disney layoff 7000. Consumers bring forward purchases → disturbs spending patterns → difficult for firms to keep up with pattern → lower levels of output
How does high inflation affect international competitiveness and the Balance of Payments (BOP)?
UK inflation rises faster than abroad → price of domestic goods increases → exports more expensive → imports more competitive → ↓ AD
How can high inflation affect financial stability?
Increased chance of bank failure, Wage increases → spiral inflation, Trade union → strikes → riots for high wage
How does high inflation affect consumption through mortgages?
High inflation = ↑ interest rate = ↑ mortgages rates → decreased disposable income → ↓ Consumption → ↓ AD → possible recession
How does high inflation affect consumption through savings?
Higher savings rate (although savings rates normally lag behind as banks want to keep profits) → ↑ savings → ↓ consumption + ↓ investment → ↓ AD
Summarise the costs of high inflation mentioned in the sources.
Higher unemployment due to higher interest rates, Decreased consumption due to higher rates on mortgages and higher savings rates, CA deficit as exports are no longer competitive, Bank failure more likely
What are the costs of high deflation in terms of economic growth?
↓ Prices → consumers and firms delay purchases for non-necessary things → ↓ demand for goods and services → ↓ production/revenue + ↓ consumption and investment → ↓ economic growth + ↓ employment
How does deflation affect employment?
Firms have decreased demand for their products. This means that in order to cut costs to stay profitable they will need to lay off workers. This increase unemployment in the economy
How does deflation affect the debt burden?
Deflation leads to the real value of people’s debt to increase because if deflation is sustained people’s incomes will start to decrease while the debt stays the same. Putting a financial burden on the government and individuals
How does deflation affect asset prices and savers?
Savers see their real value of savings grow as prices are falling which encourages households to save their money → ↓ AD
Explain how deflation can lead to a liquidity trap.
If interest rates are already low, deflation can cause a liquidty trap as CB’s decreasing interest rates could do nothing to the economy. This is what happened to Japan in the 80s with a ZIRP which led to low business and consumer confidence
Summarise the costs of high deflation mentioned in the sources.
Low growth + unemployment as consumers move back purchases, Liquidity trap making deflation incredibly hard to get out of, Increase debt burden for governments and individuals
What is the benefit of a low (around 2%) inflation rate in terms of price stability?
A low inflation rate means that prices of goods and services are stable overtime, which can give consumers and businesses greater confidence in planning for the future. This reduces the uncertainty associated with volatile prices
How can a low inflation rate support economic growth?
Low inflation can support economic growth by encouraging investment and consumption. When prices are stable, consumers and businesses are more likely to invest and spend, leading to higher economic activity
How does a low inflation rate affect international competitiveness?
A low inflation rate can also help maintain competitiveness in international markets. If an economy’s inflation rate is higher than that of its trading partner its exports become more expensive
How does a low inflation rate affect interest rates and investment?
A low inflation rate allows for interest rates to be low, which can beneficial for borrowers and increase investment in the economy
Summarise the benefits of a 2% inflation rate mentioned in the sources.
International competitiveness, Low interest rates means that you can borrow for cheaper and expand the business’, Price stability + encourage FDI this prevents foreign firms hedging against inflation, Economics growth as an increase in investment and consumption boost AD
Explain the impact of a base rate increase on asset prices.
Base rate ↑ → Com B’s want to invest in risk-free CB’s with ↑ interest rates → Causing Com B’s to sell their assets → ↑ Supply of assets → ↓ asset prices (Price of stocks and bonds ↓ → yields increase → ↓ investment + ↓ consumption due to wealth effect → ↓ AD → ↓ inflation rate
Explain the impact of a base rate decrease on asset prices.
Base rate ↓ → Com B’s move money away from CB’s as rate of return is not high → Com B’s want to spend this money on assets → ↑ price of assets (stocks and bonds) → easier for companies to raise equity → ↑ investment + ↑ consumption due to wealth effect → ↑ AD → FOP become more scarce → ↑ inflation
Explain the impact of a base rate decrease on market interest rates.
Base rate ↓ → Com B’s want to take money out of CB’s → look to give out more loans to profit max → To incentivise people to take loans Com B’s will decrease market rates to borrowers → ↑ Consumption in the economy → ↑ AD → FOP become more scare → ↑ Inflation
Explain the impact of a base rate increase on market interest rates.
Base rate ↑ → ROI for Com B’s leaving money in risk-free CB’s increases → Com B’s will put more money into CB’s → As Com B’s now have a risk free option they will only give out loans at a higher rate → ↑ market rates → ↓ consumption + investment → ↓ AD → ↓ Scarcity of FOP → ↓ Inflation rate. Com B’s also sell securities such as corporate or gov bonds increasing bond yields and decreasing investment. Savings rates will increase, and banks need to increase lending rates.
Explain the impact of a base rate increase on exchange rates.
Base rate ↑ → Com B’s domestically will move more money into domestic CB as they will get a higher rate of return → By doing this Com B’s will need to buy up pounds (hot money flows) → Appreciating the currency → ↓ domestic competitiveness → ↓ exports → + makes imports cheaper → Imports are cheaper → COP ↓ → ↓ cost-push inflation → + AD ↓ as exports ↓ → FOP become less scare → ↓ Inflation
Explain how Quantitative Easing (QE) works.
CB prints money → To get this money into the economy CB buys gov bonds from Com B’s → Com B’s will have excess cash → They want to lend this cash out quickly to gain a profit → To incentivise borrowing they will lower interest rates + Com B’s will also buy assets of their own → Increasing demand for assets → increasing price (Wealth effect → Increasing consumption, Price of assets increases → yields will decrease → Easier for firms to borrow money → Increasing investment) → Boosting AD
Explain how Quantitative Tightening (QT) works
CB ceases purchase of securities and lets bonds they have acquired mature → Decreased bond buy up → decrease bond prices → bond yield increase → More expensive to borrow money → decreased investment.
How might the expectation of a base rate increase affect asset prices?
You might want to short assets as you believe that a base rate rise will cause decreased asset prices
How might the expectation of a base rate increase affect the exchange rate?
You might also want to buy the pound as you believe that it will increase in price before it happens
How can the expectation of a base rate increase affect wage inflation?
If you believe that the base rate is going to increase and it will work and decrease inflation then wage inflation may actually decrease just by having faith in the central bank which makes a self fulfilling prophecy
How can expectations about central bank actions affect the rate of inflation?
These things by themselves will bring about a change in the rate of inflation
Define Fiscal Policy.
Manipulation of government spending and taxes in an effort to alter the level of aggregate demand in the economy
What are some sources of government spending?
NHS, Education, Social protection (unemployment benefits + welfare benefits), government debt interest and defence + transport
What are some sources of government revenue?
NIC, VAT, corp tax, income tax, excise duties, business rates and council tax
How does increased government spending impact aggregate demand?
↑ Gov spending → ↑ AD as AD = C + I + G + (X-M). Gov spending leads to multiplier → gov spending creates jobs → people use their income on consumption → further increasing AD
How do decreased direct taxes impact aggregate demand?
↓ Direct taxes (income or capital gains) → ↑ people have more disposable income → ↑ consumption → ↑ AD
How can government spending impact the supply-side of the economy?
Gov spending on transportation → decrease geographical immobility → quantity of labour. ↓ corporation tax → ↓ COP to firms → encouraging investment. Subsidies to industries
Define a Direct Tax.
A tax directly on an individual or organisation – normally taxes on income, profits and wealth
Give examples of Direct Taxes.
Income tax, NIC – a tax on earnings, Corp tax, Capital gain tax
Define an Indirect Tax.
A tax on goods or services – normally taxes on expenditure
Give examples of Indirect Taxes
VAT, Excise duties, Stamp duty, Council tax, Business rates
What is the purpose of taxes?
The purpose of taxes is to raise government revenue for SSP and to redistribute income in the economy and reduce inequality
Define a Progressive Tax.
The proportion of income paid in tax rises as the income of the taxpayer rises
Define a Regressive Tax.
The proportion of income paid in tax falls as the income of the taxpayer rises
Define a Proportional Tax.
The proportion of tax remains the same while income changes
How are direct taxes typically structured in the UK in terms of progressivity?
Tends be progressive due to the way they are structured in the UK
How are indirect taxes typically structured in terms of progressivity?
Tends to be regressive. Lower-income earners are spending a larger proportion of their incomes on goods
What is the difference between a budget deficit and national debt?
The budget deficit is normally the amount of borrowed money in a single year but the national debt is the total borrowed money
Explain how a large budget deficit/national debt can lead to crowding out.
Large gov more likely to have a large budget deficit → Needs to sell more gov bonds → This causes a shift to the right in demand for money by the government increasing all interest rates → A surplus in the bonds market means investors will only buy bonds at lower prices → Increasing yields on bonds → this incentivises invest to invest in the public sector rather than the private sector decreasing the ability of private sector to raise equity → decreasing investment
How does a high national debt affect bond yields?
When the national debt is too high bond yields increase as speculators believe the debt is too risky w/ a high chance of default
How can a high national debt or bad fiscal policy lead to currency speculation?
When the national debt is so high or when bad fiscal policy is implemented currency speculators lose faith in your economy → Sell domestic currency → Depreciating the currency → imports more expensive → if you are an import-based economy this is detrimental
How can a high national debt affect the financial account?
If the national debt becomes too high, then UK guilts may become less attractive to have on an investment portfolio which means that the financial account will be negatively affected. This can then lead to countries needing to reduce their CA deficit which can then lead to protectionist sentiment which can lead to retaliation
Define Automatic Stabilisers.
This is an argument against constant government intervention and is an argument for high taxes
How do automatic stabilisers work during an economic boom?
When EG ↑ → ↑ Incomes → people go to high tax brackets. Simultaneously less people are claiming unemployment benefits. This causes government expenditure to decrease. This causes there to be a slight AD ↓ in times of high economic growth
How do automatic stabilisers work during an economic recession?
EG falls → incomes are falling → tax revenues fall. More people claiming unemployment benefits → Gov spending ↑ → ↑ AD slightly
What is the purpose of automatic stabilisers?
The purpose of automatic stabilisers is to prevent the economy from experiencing huge economic fluctuations in the business cycle
Define Supply-Side Policies (SSP).
Policies designed to increase the productive capacity of the economy, shifting LRAS to the right
What is the role of the government in Interventionist Supply-Side Policies?
Interventionist SSP promote the role of the government
How can government spending on education and training act as an Interventionist SSP?
↑ skills of the workforce → ↑ Productivity of the workforce → ↑ Quality of labour + ↓ LR COP for firms → Shifting LRAS to the right → ↓ occupational structural unemployment → Training will bring those people back into the workforce → ↑ Quantity of labour → Shifting LRAS to the right
How can government spending on infrastructure (e.g., transport) act as an Interventionist SSP?
↓ geographical immobility → ↑ Quantity of labour force → Shifting LRAS to the right → ↓ COP for firms (Easier/cheaper to access raw materials, Easier/cheaper to sell goods)
How can government spending on schools and hospitals act as Interventionist SSPs?
Schools help the economy seep the benefits of an increase in education levels. Hospitals (This is mostly for LEDC’s) lead to Increased productivity, Increased sanitation, Decreased infant mortality
How can government subsidies act as an Interventionist SSP?
Promote investment + R&D (UK government subsidies renewable energy, The US has its inflation reduction act which will be spending). Investment ↑ Quality + Quantity of capital → Reduce LR cost of production for businesses
What is the role of the government in Market-Based Supply-Side Policies?
Market-Based SSP reduce the role of the government
How can lower income tax act as a Market-Based SSP?
Economically inactive + people outside labour market have incentive to return → This ↑ the quantity of labour. Those who are in work may be incentivised to work harder → Could ↑ quality of labour → Shifting LRAS to the right
How can lower corporation tax act as a Market-Based SSP?
Firms will have more retained profits → Can use profits to invest → innovation → This can improve quality and quality of FOP’s and improve productive efficiency by reducing LR costs
How can reducing benefits act as a Market-Based SSP?
Strong incentive for economically inactive to enter the labour force (E.g. 2010 - Universal credit forcing people back into the labour force) → ↑ Quantity of labour → Shifting LRAS to the right
How can competition policy (privatisation, deregulation, trade liberalisation) act as a Market-Based SSP?
All of these policies improve competition in the economy forcing firms to decrease their COP and innovate → Boosting quantity and quality of FOP and boosting productive efficiency
What is a limitation of Supply-Side Policies regarding their success?
No guarantee of success (E.g. Sri Lanka wanted to build a new port to improve its infrastructure and trade but this was deemed to be useless and can just lead to huge debts)
What is a significant cost-related issue with Supply-Side Policies?
Most SSP’s are going to be financed through debt if you are an LEDC and tax revenues if you are a MEDC. Debt to GDP ratio is 97% → This leads to problems of having a high national debt
What is a significant time-related issue with Supply-Side Policies?
Interventionist policies take decades for benefit to reap (E.g. education spending). Market based tax cut take a long time until we see investment increases or people joining work force. This all means that SSP cannot really sort out short term problems in general instead they should be aimed at solving fundamental issues in an economy
What are some potential negative stakeholder impacts of Supply-Side Policies?
Living standards may decrease from labour market reforms (If there is a lowering of trade union support in monopsony markets this may be detrimental). Deregulation could lead to moral hazard or environmental laws
How can the current economic situation (output gap) affect the effectiveness of SSP?
If economy is in a recession and we use SSP this will just further increase the negative output gap
What does the source suggest about the implementation of Supply-Side Policies?
Need for targeted SSP
