chapter 10 flashcards
what is national income
the flow of new output produced by an economy in a time period
what is the difference between real national income and nominal national income
nominal national income is the total amount of money the country produces from goods and services in a given period of time, while real income is the nominal income adjusted for inflation.
what are 2 synonyms for national income
national output
national expenditure
describe the circular flow of income
- households spend their incomes on the goods and services that firms produce
- firms pay households for labour in wages
what may happen in a more realistic version of the circular flow of income
households may withdraw money by saving and firms may have injections of investment
what type of economy is present in the circular flow of income + describe
a closed economy - has no government sector or international trade
what is equilibrium national income
- 2 definitions
-the level of income at which withdrawals equal injections into the flow of income
-the level of output at which aggregate demand equals aggregate supply
what causes national income to be in equilibrium, to rise and to fall
- if planned saving equals planned investment, national income is in equilibrium
- if withdrawals exceed injections, it causes income and output to fall
- if withdrawals are less than injections, output and income will rise
what is aggregate demand
total planned demand of goods and services in the economy at a given time and price level
AD equation
AD = C+I+G+(X-M)
what is aggregate supply
amount of goods and services produced within the economy at a given price level
AND
the level of real national output that producers are prepared to supply at different average price levels
describe an AS curve
the AS curve sloped upwards because all firms aim to maximise profits, and when the price of a good increases, firms will buy more of it to sell it at a high price to get more profit
what does the LRAS curve represent
the real output that can be supplied when the economy is on its PPF
- when all available factors of production are employed and are producing at their normal capacity
what shifts a PPF, and in which direction
- an increase in the quantity or quality of factors of production such as land, labour or capital shifts the PPF outwards, and the LRAS shifts right
what is an economic shock
an unexpected shock hitting the economy, disturbing either AD or AS
what is aggregate consumption
spending by all of the households in the economy on consumer goods and services
what are determinants of consumption
(only terms)
- interest rates
- level of income
- expected future income
- wealth
- the availability of credit
- distribution of income
- expectations of future inflation
how do interest rates determine consumption
interest rates rewards savers for sacrificing their consumption and the higher rate, the higher reward, and less consumption because of that
how does level of income determine consumption
when income increases, consumption increases but not by as much as income is increased by, due to saving
how does expected future income determine consumption
people plan their savings on the basis of an idea of their future income
how does wealth determine consumption
houses and shares are people’s main wealth asset, so when house prices rise, borrowing increases and consumption is likely to fall
how does the availability of credit determine consumption
if credit is cheap and interest rates are low, consumption increases as people use credit as income, however tight monetary policy and high interest rates reduce consumption
how does the distribution of income determine consumption
the rich save more than the poor, affecting consumption trends
how do expectations of future inflation determine consumption
uncertainty of rising inflation reduces consumption as people are saving more
what are the two things people can do with their income
save or consume
what is saving
the income not spent on consumption
what is physical investment
buying new capital goods like machinery and office equipment
what is financial investment
into shares and bonds
what is the difference between saving and investment
saving is simply income not spent on coonsumption, and investment is spending by firms on capital goods or financial assets
what are the two types of a country’s gross investment
replacement investment - replacing worn out capital, maintaining the size of capital stock
net investment - adds to the capital stock, increases productive potential, and is an engine of economic growth
what are the determinants of investment
- relative prices of capital and labour
- the nature of technical progress
- adequacy of financial institutions in supplying investment funds
- government support
how do the relative prices of capital and labour determine investment
- if the price of capital goods or interest rates falls, firms switch to capital intensive methods of production and so investment increases
- when the price of capital increases, firms adopt more labour-intensive production methods
how does the adequacy of financial institutions in supplying investment funds determine investment
some capital investments are hard to finance so banks provide long term investment but shares and the stock market offer short term funds
how does government support determine investment
they lend funds to firms to finance investment projects although they tax firms too
describe the accelerator process
-The basic accelerator process is an economic theory that states that when there is increased demand for a product or service, companies will invest more money to meet that demand
-This leads to higher production, more jobs, and more income for individuals, which further stimulates demand
what must firms do when real output increases (clue-fops)
they must employ more workers to produce the additional goods and services that the output increase involves
what does an expansionary effect of an increase in aggregate demand do to employment
an expansionary effect of an increase in AD leads to an increase in employment
what does an contractionary effect of an decrease in aggregate demand do to employment
an contractionary effect of an decrease in AD leads to an fall in employment
what does the national income multiplier measure
measures the relationship between a change in aggregate demand and the resulting larger change in national income
equation for national income multiplier
multiplier=change in national income/initial change in government spending
what is the marginal propensities to consume
the fraction of any increase in income which people plan to spend on consumption of domestically produced goods
what is the marginal propensity to save
the fraction of any increase in income which people plan to save rather than spend
what does a fiscal policy multiplier include
government spending and tax multipliers
what do foreign trade multipliers include
export and import multipliers
what do regional multipliers include
they measure the relationship between an initial change in aggregate demand and the resulting change in regional income
what is the multiplier formula
K(multiplier) = 1/1-MPC
or K = 1/MPS
what is the equation for nominal national income
real national income x average price level
give examples of things that change the SRAS curve
changes in costs (money wage rates, raw materials business tax) and productivity
at YFE why can’t Y (real income/output) increase anymore
because the economy is producing at its full capacity
what are some factors that cause outward shifts in the SRAS curve
- fall in business costs of production (energy, materials)
- fal in labour costs from a fall in wage costs or increase in productivity (better training)
- reduction in taxes like VAT from government
- increase in subsidies granted to firms by the government
- technical progress which improves quality and productivity of capital foods
what does the LRAS curve represent
the economy’s productive potential
where is the LRAS curve located
at the normal capacity of output, where full productive potential of the economy is being used
what are some factors that change the position of the LRAS curve
- state of technical progress
- quantities of capital and labour and other factors of production in the economy
- mobility and productivity of FOP, especially labour
- people’s attitudes to hard work
- people’s enterprise
- the existence of appropriate economic incentives
- the institutional structure of the economy, involving factors such as law and efficiency of the banking system
real life example showing the inability of banking systems to provide finance + how it relates to LRAS shifts
the financial crisis in 2007/8 showed the inability of banking systems to provide finance to business, shifting the LRAS left, deepening the recession
