Chapter 6 Flashcards
What are the four major objectives of government?
1) Employment
2) Inflation
3) Growth
4) Balance of Payments
These four are sometimes called the ‘economic diamond’
What are the additional two objectives that government would like to achieve in an ideal world?
1) Redistribution of wealth in favour of the poor
2) To protect the environment
Explain the ‘Employment’ objective
-To maintain low levels of unemployment.
-Anyone who wants a job but doesn’t have one will only be out of work for a short period of time
Explain the ‘Inflation’ objective?
-Inflation is usually defined as a sustained rise in the general level of prices.
Generally, governments are happy if they can keep the inflation rate down to a low percentage
What is the technical definition of inflation?
Inflation is measured as the annual rate of change of the RPI (Retail Price Index)
RPI is often refered to as the headline rate of inflation
What type of inflation does the UK Government target?
-UK Gov prefers to target the underlying rate of inflation
-This is the annual perscentage change in the RPIX.
-The RPIX is the same as the RPI except housing costs are removed in the shape of mortgage interest payments
Explain the ‘Growth’ objective?
Governments want high but sustainable growth
-Economic growth tends to measured in rate of change of real GDP
real = inflation has been removed
Explain the ‘Balance of Payments’ objective?
-The balance of payments that flows into and out of the UK
-As a generalisation, Govs want this in eqm
What tools can the government use to acheive the ‘economic diamond’ objectives? (Main two categories)
-Demand side policies
-Supply side policies
What are ‘Demand side policies’?
Policies that aim to influence aggregate demand within an economy
-The two main components of these policies are
–Fiscal policy: Gov spending and taxation
–Monetary policy: supply of money, Int Rates, XR and the availability of credit
What are ‘Supply side policies’?
Supply side policies aim to stimulate growth by influencing the supply within the economy by promoting competition, reducing trade union power and use of tax incentives
What is Macroeconomics?
Macroeconomics is concerned with decisions that affect the economy as a whole
What are the three ways of measuring the size of the flow of an economy?
1) The output method: The total amount of goods and service produced in one year
2) The expenditure method: The total amount of domestics spending by consumers, government, and foreigners
3) The income method: The total incomes earned by the factors of production involved in the production of goods and services in one year
The result of each of the three methods is GDP.
What is national income accounting?
NIA is the process whereby countries attempt to measure these flows.
What is GDP?
Gross Domestic Product (GDP)
GDP measures the value of output produced within the domestic boundaries of the UK
–It includes the output of the many foreign-owned firms that are located in the UK
–It excludes the value of the output produced by UK firms located overseas
GDP is sometimes called Gross Value Added (GVA)
What is GNP?
Gross National Product (GNP) measures the output from assets belonging to the country’s population and hence includes earnings from investments abroad.
This measure is not therefore confined to the boundaries of the country itself.
What does examination of NIA give insight on?
An examination of the national income accounts gives an insight into the economy. It provides data which governments and external agencies can use in a variety of different ways.
Including:
-To determine extent of economic growth
-To measure changes in living standards over time
-To make comparisons of economic performance and living standards between countries
-To examine and judge the performance
How does a government go about increasing overall national income?
If a government wants to increase overall national income by $500m then it will not be necessary to directly spend $500m, it can be achieved with a lower initial boost to spending.
Together, two fundamental principles create this effect:
-The multiplier principle
-The Accelerator principle
What is a basic explanation of the Multiplier principle?
- The multiplier principle suggests that you can stimulate an economy with a relatively small initial increase in spending because an initial injection into the economic system (eg gov spending) will trigger further rounds of spending
What is consumption and what are its two components?
When households spend money with firms for goods and services
Two components:
-Autonomous consumption
-Income induced consumption
What is Autonomous consumption?
Consumption that is not income dependent.
(Even if you didn’t earn any money you would still consume (e.g. food). You would have to rely on savings,
welfare payments and borrowing.)
What is Income induced consumption?
consumption that increases as your level of income increases. It is driven by your marginal propensity to consume
What is MPC
MPC = Marginal propensity to consume.
-represents the proportion of any additional income earned that is spent on consuming goods and services.
General observations are that poorer people have a higher MPC and that in a developed economy a normal MPC will be in the region of 0.7 – 0.8
What is APC?
The Average Propensity to Consume (APC) is calculated by taking total consumption ÷ income.
How can the overall consumption function be represented?
C = a + bY
Where a = autonomous consumpution
b = MPC
Y = Income level
How is the value of the multiplier found?
Multiplier = Final change in national income/ Initial change in aggregate demand
What injections are income dependant?
C - a fixed element and income dependent elemement
G, I, X-M are all assumed to be non-income dependant
eqn for an economy to be in equilibrium?
E = Y
Where E = C + G + I + (X-M)
and Y = national Income
The E vs Y graph is therefore 45*
E = Planned expenditure
Y =National Income
In context of a Planned expenditure (E) vs National income (Y) graph. When does growth occur?
Growth is likely to occur if E > Y
Equilibrium will occur at Y(E) where the expenditure line intersects the 45* E=Y line