CH9:Circular Flow of Income and Monetary Policy Flashcards
In MACROeconomics, what is the economy made up of?
P - Production - what is made and bought
I-Income (aka the money supply)
C-Consumption - what is consumed
In the circular flow of money diagram - how is the size of the economy measured?
Measure day the total amount spent ie. Aggregate demand (total demand)
What are examples of withdrawals?
Taxation
Savings
Imports
What are examples of injections?
Borrowing (to invest)
Government spending
Exports
How does inflation affect savings?
When inflation rates are greater than interest rates, people are disincentivised to save, as the real value of their money will fall
Definition: tax relief
taxes which have already been paid are reimbursed
Definition: Investment
the purchase of an item in the hope it will generate income or accrue value
How do new or replacement investments affect investments?
Replacement investment is spending on replacing items. There is an increase in investment when net investment is positive :
Net investment = New investment - replacement investment
(ie. how much are actually new investments, new investments tend to grow the economy whilst replacement investments tend to keep things at the current level)
Definition: National income
The total amount of goods and services produced over the course of a year, which is equal to the total amount earned by all people and businesses
How do governments use Monetary policy to manage the economy?
- *Changing interest rates - key element of monetary policy
- Making borrowing and lending easier or harder
What are consequences of increased interest rates?
- Decreased investments - borrowing is more expensive and so decreases
- Attraction of foreign funds - foreign investors move their funds to take advantage of interest rates (“hot money”)
- Effects on the exchange rate - An inflow of foreign funds increases demand for that currency, leading to an increased exchange rate
- Decreased inflation rates - high interest rates will encourage people to save vs. spend, reducing the pressure on prices
- Decrease in asset value - assets which depend on the interest paid for their value (corporate or government bonds) may fall in value. ie. the existing bonds will not be as attractive as new bonds which are issued with higher interest rates vs. the old bonds.
- Affect on sales - sales may fall as people choose to save more and borrow less
* Decreased interest rates will have the opposite effect
Definition: balance of payments
Looks at the value imports and exports and the difference between them
What is the balance of payments made up of?
3 accounts:
- Current account
- Capital account
- Financial account
What is included in the CURRENT ACCOUNT?
Monies from:
Visible trade: trade in goods
Invisible trade: Trade in services, overseas income eg. salaries earned overseas or dividends paid out.
transfer of money to friends, foreign aid.
What is included in the CAPITAL ACCOUNT?
Monies from buying/selling fixed assets (capital) eg. purchasing machinery
What is included in the FINANCIAL ACCOUNT?
Monies from:
- Overseas investments eg. buying shares in an overseas company, or setting up a manufacturing facility overseas
- Reserve assets
- A balancing item
Definition: reserve assets
There are assets held by the government in reserve eg. gold or foreign currency
What is the balancing item?
The balance of payments is set up so that the sum of all 3 accounts is 0 by using a balancing item:
Current Ac + Capital Ac + Financial Ac + Balancing item = 0
What is a surplus in the balance of payments?
An INJECTION into the economy
What is a deficit in the balance of payments
A WITHDRAWAL from the economy)
What determines the balance of the CURRENT ACCOUNT?
the level of IMPORTS/EXPORTS
What is the main area of concern regards to the balance of payments?
if the CURRENT ACCOUNT is constantly in deficit
ie. imports > exports
Definition: import penetration
the extent to which Imports are increasing
Definition: export performance
the extent to which exports are being sold