Ch 6: Macroeconomic Activity Flashcards
What is macroeconomics?
studies the economy as a whole. It focuses on the business cycle - why economic activity fluctuates, inflation, unemployment, economic growth and govt. economic activity
What are the government’s macroeconomic objectives?
- Price stability (low levels of inflation 2-3%)
- Unemployment (low levels 4.5%, 4-5%)
- Economic growth (3-4%)
- Equitable distribution of income - fairer Gini coefficient. Achieved through direct taxation, transfer payments and indirect payments
- Efficient resource allocation - regulations and microeconomic reforms i.e. labour market efficiency improvements
- External balance - make sure can service debit. Not a problem in Australia
What are the assumptions of the simplified circular flow?
- there are only 2 sectors
- households: owners of factors of production resources and the buyers of final g & s
- firms: employers of resources and produce all the g & s in the economy to the consumers
- households spend all their income on g & s
When is the economy in equilibrium?
When income = output = expenditure (Y=O=E)
How do you increase/expand the circular flow of income?
increase output (by investing) which will increae income which will increase expenditure
What are the types of resources?
Land
- all natural resources
- paid for by rent
Labour
- all work done by humans, can be skilled and unskilled
- paid for by wages
Capital
- machinery and equipment used in the production process
- paid for by interest
Enterprise
- combines other resources to produce g & s
- paid for in profit
What is the product and factor market?
product market: households and firms spend the income they have earned on g & s produced by business firms
factor market: firms hire resources from households, in return for which housholds receive income
What does the expanded circular flow look like?
What are the components of the capital market/financial sector?
- savings - proportion of income not spent on g & s for current consumption. LEAKAGE
- investment - ecpenditure on g & s which are not intended for current consumption (purchase of capital goods). Leads to increase production of g & s, increasing future flow of income. Is an INJECTION as is adds to the stock of capital equipment in the economy
What are the components of the government sector?
- taxation - households pay some of their income to the government. LEAKAGE
- government expenditure - INJECTION
- G1: current expenditure (spending on g & s such as wages, salaries, fuel, power, stationary)
- G2: capital expenditure (spending on capital/investment goods, sometimes called infrastructure includes schools, roads, railways, hospitals)
What are the components of the overseas sector?
- imports (M) - transaction when the money flow goes from Aus. to overseas. LEAKAGE
- exports (X) - money flow is from overseas to Aus. INJECTION
What is GDP?
Gross Domestic Product is the toal market value of all final g & s produced in a country in a period of time. Most frequently used measure of economic performance
How is GDP measured?
- Income and earnings approach: all incomes (y/national income) received are added allowing for depreciation of capital equipment and net indirect taxes
- Expenditure approach: total expenditure on g & s produced is measured, AE = C + I + G + (X-M). Imports are subtracted because households and firms spend money on them
What is MPC and MPS and what does it equal?
MPC - Marginal Propensity to Consume, determines the slope of the consumption curve i.e. if MPC = 0.6, for every $1, $0.60 is spent and $0.40 is saved
MPS - Marginal Propensity to Save
MPC + MPS = 1
What is the consumption component of aggregate expenditure?
CONSUMPTION (C)
- expenditure on non-durable goods i.e. food, clothing
- expenditure on services i.e. health, plumbers, mechanics, education
- expenditure on consumer durables i.e. white goods, furniture, cars
What is the investment component of aggregate expenditure?
INVESTMENT (I)
- business expenditure on new capital equipment which will produce final g & s in the future. Is planned
- fixed investment - privately funded expenditure on equipment and structures used in production
- residential fixed investment - private expenditure on new housing
- changes in business inventories - stocks of goods that have been produced
What is the government component of aggregate expenditure?
GOVERNMENT (G)
- G1 - current expenditure which provids for day to day functions of govt.
- G2 - capital expenditure to provide for future needs such as schools, roads, power, communication, dams etc. (can be altered)
What is the net exports component of aggregate expenditure?
NET EXPORTS (X-M)
- the value of g & s sold to oversease minus the value of g & s bought from overseas
What are the factors affecting consumption spending?
- disposable income (YO) in the community - households plan to spend more on consumption at higher levels of income
- the cost of credit (interest rates) - falling interest rates tend to have a positive effect on aggregate consumption
- stock of personal wealth - housholds that hold property/shares tend to ‘feel’ more wealthy when the value of those assets are rising and thus more likely to spend on durable consumption
- expectations - more likely effect spending on items such as holidays and durable goods
- government policies - fiscal policy affects disposbale goods and taces can affect the price of some goods. Monetary policy affects interest rates and therefore the cost of credit
What are the factors influencing investment expenditure?
-
rate of interest (charged in borrowed funds) - as interst rates rise, levels of investment fall
- nominal rate: current price of borrowed money
- real rate of interest: current price + takes into account inflation
- business expectations - what business think about the current level of economic activity/forecasts for the future and the impact of them on profitability. If business expectations are + then investment rises
- government policies - fiscal + monrtary policies affect investment levels because they affect business costs and their general influence on the level of economic activity (also + regulations)
- profitabilty - difference between revenue and cost of production. When profits rise, investment generally rises
What are the factors affecting the government expenditure component of aggregate expenditure?
GOVERNMENT EXPENDITURE
- determined in accordance with government policy objectives
- G1: slowly grows over time as population rises, current expenditure
- G2: need and economic conditions
- social and political influences
- stabilise macroeconomic fluctuations
What are the factors affecting the net exports component of aggregate expenditure?
- economic activity
- domestic: Aus.’s propensity to import when GDP rises, imports rise and also agricultural conditions
- overseas: demand for Aus. products
- exchange rate - determined by market forces, when $A appreciates one AUD can buy more units of other currencies, but exports are more expensive to other countries
- tarrifs, quotas
- terms of trade - if Aus. products are in demand on overseas markets, the terms of trade rise and the prices received for exports improve, meaning the value of export sales will rise
What is the durable and non-durable consumption?
DURABLE CONSUMPTION: expenditure on durable goods (about 15% of consumption spending) - goods that are expected to last (provide satisfaction for more than 3 years)
NON-DURABLE CONSUMPTION: accounts for 35% of consumption spending, expenditure on goods that are consumed quickly after purchase (last up to 3 years)
How do you calculate real rate of interest?
real rate of interest = nominal interest rate - inflation
