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A-Levels > E - 10) How the macroeconomy works: the circular flow of income, AD/AS analysis and related concepts > Flashcards

E - 10) How the macroeconomy works: the circular flow of income, AD/AS analysis and related concepts Flashcards

1
Q

What is national income?

A
  • The monetary value of the flow of output produced in an economy over a period of time
  • National income can be measured at any point because income flows around the economy, so national income = national expenditure = national output
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2
Q

What role do households have in the CFoI?

A
  • Own the productive resources of the nation, which they exchange for rent, wages, interest and profit with firms
  • They use the income earnt to buy goods and services from firms
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3
Q

What role do firms have in the CFoI?

A
  • Hire the resources as inputs to use them to produce output.
  • They sell the goods and services produced, to households
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4
Q

What effects do different sectors have on the CFoI?

A
  • Financial sector: not all income is spent, any saved is lent to businesses to invest
  • Government sector: some income is taken out of the flow as tax, but they also spend which injects income into the CFoI
  • Foreign sector: some income flows out to other countries when imports are purchased, exports add to the CFoI because income comes in from outside the economy
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5
Q

What are the injections and withdrawals of the CFoI and what do they cause?

A

Injections:

  • Investment (I)
  • Government spending (G)
  • Exports (X)
  • They add money to the flow, which leads to economic growth

Withdrawals:

  • Savings (S)
  • Taxation (T)
  • Imports (M)
  • They remove money from the flow, which leads to economic contraction
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6
Q

What are the different balances of national income equilibrium and what do they cause?

A
  • Planned injections = planned withdrawals: national income equilibrium
  • If injections exceed withdrawals: national income rises (economic growth)
  • If withdrawals exceed injections: national income falls (economic contraction)
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7
Q

What is wealth with examples?

A
  • (Stock concept) – the value of assets held
  • Examples: income saved, value of shares, value of property owned, money held in pension funds
  • Wealth is more unevenely distributed than income
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8
Q

What is income with examples?

A
  • The flow of money going to factors of production
  • Examples: wages, salaries, rent, profits, people receiving benefits, interest paid
  • Income is less unevenely distributed than income
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9
Q

What is the aggregate demand (AD) curve and its formula?

A
  • Shows the relationship between the level of real planned expenditure and the genral price level in an economy
  • AD = C + I + G + (X - M)
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10
Q

What are the types of movement along the AD curve?

A
  • Extensions - movement to the right - fall in general price level causes higher real GDP
  • Contractions - movement to the left - rise in general price level causes lower real GDP
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11
Q

Why does the AD curve have an inverse relationship?

A
  • Real income effect
  • Balance of trade effect
  • Interest rate effect
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12
Q

What factors shift the AD curve?

A

Changes in:

  • Real income and employment
  • Consumer and buiness confidence
  • Household wealth
  • Monetary policy
  • Fiscal policy
  • Exchange rate and the global economy
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13
Q

What are characteristics of consumption in terms of AD?

A
  • Consumer spending on real output
  • Examples: non-durables, durables, services
  • Largest component of AD - about 60%
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14
Q

What are characteristics of investment in terms of AD?

A
  • Spending on capital goods that help produce more consumer goods in future
  • Examples: plant, equipment
  • Investment demand comes from both private and public sector
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15
Q

What are characteristics of government spending in terms of AD?

A
  • Spending by the government on its current day-to-day provision of public services
  • Examples: healthcare, education, defence, transport
  • Does not include transfer payments (pensions and welfare benefits)
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16
Q

What are characteristics of net exports in terms of AD?

A
  • Exports are inflows of demand from citizens abroad
  • Imports are outflows of demand for foreign-produced goods
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17
Q

What factors affect consumption?

A
  • Income
  • Wealth effect
  • Consumer confidence
  • Job security
  • Interest rates
  • Demography
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18
Q

What are benefits and drawbacks of rising consumption?

A

Benefits:

  • Rising AD
  • Faster short run economic growth
  • Less spare capacity
  • Falling unemployment
  • Gives businesses confidence to invest

Drawbacks:

  • Inflation pressure
  • Current account deficit (more imports sucked in)
  • Unbalanced growth
  • More household debt
  • Bad for the environment
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19
Q

What is the fotmula for savings ratio?

A

Savings ratio = total household savings ÷ total household disposable income

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20
Q

Why is saving money important for economies?

A
  • Savings flow into financial markets and businesses can access these funds to invest
  • Savings provide households with a cushion of financial stability and funds for the government when it needs to borrow
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21
Q

What is the Keynesian paradox of thrift?

A

Economic theory which states that an increase in saving can lead to a decrease in economic activity and a decrease in overall saving

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22
Q

What is the formula for average propensity to consume?

A

APC = consumption ÷ national income

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23
Q

What is the formula for marginal propensity to consume?

A

MPC = ∆ consumption ÷ ∆ national income

24
Q

What is the formula for average propensity to save?

A

APS = saving ÷ national income

25
Q

What is the formula for marginal propensity to save?

A

MPS = ∆ saving ÷ ∆ national income

26
Q

What is investment with examples?

A
  • Addition to capital stock of the economy
  • Examples: factories, machines, offices, equipment, stocks of materials used to produce other goods
27
Q

What is depreciation in terms of capital consumption?

A

Value of the capital stock that falls in value over time as it wears out or is used up

28
Q

What is gross and net investment?

A
  • Gross: investment before depreciation
  • Net: gross investment minus depreciation
29
Q

What is private and public sector investment with examples?

A
  • Private sector: investment undertaken by businesses in the private sector
  • Public sector: investment by the government often in infrastructure. Examples: transport, telecommunications, energy networks, new schools, new hospitals
30
Q

What is foreign direct investment (FDI):

A

Capital investment made by companies based in one country, into another country

31
Q

Why do firms invest?

A
  • Expand their business and increase their output capacity
  • Reduce average costs of production due to economies of scale
  • Increase efficiency and productivity through innovation and technological progress
  • Meet an increase in market demand and increase market share
  • Expand firm’s product range
  • Replace depreciated capital
  • Increase competitiveness at home and abroad
32
Q

How does investment impact AD and AS?

A
  • AD: adds to AD - short-run growth - lower
    unemployment
  • AS: adds to economy’s capacity - LRAS - long-run non-inflationary growth
33
Q

What factors affect investment?

A
  • Interest rate
  • Availability of finance
  • Demand for the final product
  • Business confidence
  • Corporate taxes
  • Business regulation
  • Technological change
34
Q

How does investment affect the macroeconomy?

A
  • Creates extra demand in investment goods industries
  • Injects money into the circular flow of income (multiplier effect)
  • Boosts both short-run and long-run economic growth
  • New capital boosts productivity and increases the capacity to supply
  • Improves a country’s competitiveness, improving the trade balance
  • Improves an economy’s infrastructure to make it more efficient
  • Can help create new jobs (though some may be lost to automation/AI)
  • Can help reduce inflation pressure
35
Q

What is government spending?

A
  • Day-to-day running costs of government
  • Examples: wages to public sector workers, energy and rent bills for government offices schools and hospitals
  • Also known as current spending by the government
  • Does not include transfer payments like government spending on welfare benefits or pensions
36
Q

What is central and local governemnt?

A
  • Central: run at Westminster
  • Local: local and county councils and city mayors
37
Q

What is the role of governemnt spending?

A
  • Change the level of AD (with fiscal multiplier)
  • Provide public and merit goods
  • Correct market failures like positive consumption externalities
  • Influence economic regions like ‘levelling up’
  • Achieve greater equity in society by providing public services, including universal access to healthcare and education
38
Q

What is budget deficit, surplus and balanced budget?

A
  • Deficit: government spending exceeds tax revenue - government borrows to fund its spending
  • Surplus: government spending is less than tax revenue - government can pay back some of its debt
  • Balanced budget: government spending equals tax revenue
39
Q

What is cyclical government spending?

A
  • When in an economic downturn/recession, government spending increases on welfare-benefits and support for businesses. The opposite occurs in a growth phase
  • The government can also choose to make discretionary changes to its spending, unrelated to the economic cycle like in the Budget
40
Q

What is trade surplus, deficit and trade balance equilibrium and their effect on AD?

A
  • Surplus: net export demand is positive - adds to AD
  • Deficit: net export demand is negative - reduces AD
  • Trade balance equilibrium: net export demand is neutral - AD remains unchanged
41
Q

What factors affect net trade?

A
  • Real income
  • Exchange rate
  • State of global economy
  • Degree of protectionism
  • Non-price competitiveness
  • Price competitiveness
42
Q

What is the multiplier effect?

A

Occurs when an initial injection into the CFoI causes a bigger final increase in real national income

43
Q

Why does the multiplier effect happen with an example?

A
  • Because one agent’s spending is another agent’s income
  • Example: when a spending project creates new jobs, this creates extra injections of income and demand into the CFoI
44
Q

What is the negative multiplier effect?

A

Occurs when an initial withdrawal or leakage of spending from the CFoI, leads to knock-on effects and a bigger final drop in real GDP

45
Q

What is the formula for the multiplier coefficient?

A

Multiplier coefficient = final ∆ real GDP ÷ initial ∆ AD

46
Q

What is the formula for the multiplier?

A

Multiplier (k) = 1 ÷ (1-MPC)

47
Q

What is the formula for the multiplier in different economy situations?

A
  • In a closed economy with no government: k = 1/MPS
  • In a closed economy with a government k = 1/(MPS+MPT)
  • In an open economy with a government k = 1/(MPS+MPT+MPM) or 1/MPW
48
Q

What factors affect the size of the multiplier?

A

High multiplier value:

  • Economy has plenty of spare capacity
  • Propensity to import and tax is low
  • High propensity to consume any extra income

Low multiplier value:

  • Economy is close to full capacity
  • Rising demand causes inflation
  • Higher inflation causes rising interest rates

Both:

  • Size of withdrawals from the CFoI
49
Q

What is are investment, fiscal and export multipliers?

A
  • Investment: initial change from investment
  • Fiscal: initial change from governemnet spending or borrowing
  • Export: initial change from exports

…On real national income (GDP)

50
Q

Drawbacks of the multiplier?

A
  • Difficult to know exact size of multiplier - hard to measure
  • Takes time for multiplier process to feed through to real GDP – time lag
  • Economists disagree over its size
  • Long-run multiplier effect is likely higher for developing economies than for developed ones - infrastructure projects often have higher multiplier effects
51
Q

What is short run aggregate supply (SRAS)?

A

Total planned output when the general price level can change, but the prices and productivity of factor inputs are held constant

52
Q

What are the types of movement along the AD curve?

A
  • Extensions - movement to the right - fall in general price level brought about by a shift in AD, causes higher real GDP
  • Contractions - movement to the left - rise in general price level brought about by a shift in AD, cause cause lower real GDP
53
Q

What factors shift the SRAS curve?

A

Changes in any costs of production

54
Q

What is long run aggregate supply (LRAS)?

A

Total planned output when both price and average wage rate can change - measure of a country’s potential (maximum) output

55
Q

What factors shift the LRAS curve?

A
  • Change in the quantity of factors of production
  • Change in the quality of factors of production
  • Technological progress
56
Q

What is the Keynesian AS curve?

A
  • Below Y1: AS is very elastic - the economy has lots of spare capacity and any increase in AD can easily be met without inflation
  • Between Y1 and Yfe: AS becomes less elastic - less spare capacity - increase in AD can be met, but costs to businesses start to increase as firms compete for skilled labour and other scarcer resources - some inflation
  • For Yfe and above: AS is perfectly inelastic - no spare capacity - an increase in AD will cause inflation not growth
57
Q

How do shifts work on the Keynesian AS curve?

A
  • Shifts in AS (with no change in Yfe): costs of production in the economy (same as SRAS) - left side shifts, right side does not
  • Shifts in AS (where Yfe changes): productive potential of the economy (same as LRAS) - right side shifts, left side does not

A-Levels (103 decks)

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