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macroeconomics > how the economy works > Flashcards

how the economy works Flashcards

1
Q

what is economic growth?

A

an increase in real GDP (actual growth) and potential growth

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2
Q

what are the three ways of measuring economic growth?

A
  • output = total value of goods and services produced by an economy
  • expenditure = total value of purchases on goods + services
  • income = total income generated by producing goods + services
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3
Q

how do you calculate the value of a good or service?

A

value = price x quantity

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4
Q

what is the GDP deflator?

A
  • a measure of the level of prices (inflation) of all goods and services produced domestically
  • it allows economists to convert nominal to real GDP
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5
Q

how do you calculate the GDP deflator?

A

GDP deflator = (nominal GDP/real GDP) x 100

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6
Q

what does GDP stand for?

A

Gross Domestic Product

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7
Q

what is GDP?

A

the total value of all goods and services produced within a country’s geographical border in a one-year period

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8
Q

how do you calculate GDP?

A

GDP = consumption + investment + government spending + (exports - imports)

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9
Q

what does GNP stand for?

A

Gross National Product

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10
Q

what is GNP?

A

the total value of all goods and services produced by the residents and businesses of a country, irrespective of the location of production

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11
Q

what are some of the benefits of economic growth?

A
  • higher incomes
  • reduced poverty
  • better education
  • increased life-expectancy
  • improved government finances
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12
Q

what are the advantages of using GDP as a measure of economic growth?

A
  • tracks changes in the size of an entire economy, making it an important measure for economists and investors
  • serves as a comprehensive measure of economic health
  • provides insights into the factors driving economic growth or holding it back
  • enables policy makers and central banks to judge whether the economy is contracting or expanding + promptly take necessary action
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13
Q

what are some limitations of using GDP as a measure of economic growth?

A
  • it does not consider the income earned by its citizens while operating outside of the country
  • lack of information on inequality: the differences in the standards of living within the same country could be significant, GDP only provides the distribution of income as an average
  • does not include unpaid/voluntary work
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14
Q

explain the circular flow of income

A
  • firms and households interact and exchange resources in an economy
  • households supply firms with the factors of production, and in return, they receive wages and dividends
  • firms supply goods and services to households, consumers pay firms for these
  • this spending and income circulates around the economy in the circular flow of income
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15
Q

what is an injection into the circular flow of income?

A

money which enters the economy

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16
Q

what is a withdrawal from the circular flow of income?

A

money which leaves the economy

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17
Q

what are the injections into the circular flow of income?

A
  • government spending
  • investment
  • exports
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18
Q

what are the withdrawals from the circular flow of income?

A
  • taxes
  • savings
  • imports
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19
Q

what does it mean for the economy to reach a state of equilibrium?

A

rate of injections = rate of withdrawals

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20
Q

what is aggregate demand?

A

the total demand for all goods and services in an economy at any given average price level

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21
Q

what are the components of aggregate demand?

A
  • C = consumption
  • I = investment
  • G = government spending
  • X = exports
  • M = imports
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22
Q

what is the equation for aggregate demand?

A

AD = C + I + G + (X-M)

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23
Q

what is meant by consumption?

A

the total spending on goods and services by consumers in an economy

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24
Q

what are the determinants of consumption?

A
  • disposable income
  • consumer confidence
  • interest rates in banks
  • employment rates
  • wealth effects
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25
Q

what is investment?

A

the total spending on capital goods by firms

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26
Q

what is gross investment?

A

the total level of investment

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27
Q

what is net investment?

A

gross investment - depreciation

28
Q

what are the determinants of investment?

A
  • interest rates (cost of borrowing)
  • business confidence (animal spirits)
  • performance of the economy
  • foreign demand for exports
  • access to credit (bank’s willingness to lend)
  • government regulation (lowering corporation tax)
29
Q

explain how interest rates can affect the level of investment

A
  • if interest rates increase, the cost of borrowing is higher
  • deters firms from borrowing money to spend on capital
  • results in less investment
30
Q

what are the macroeconomic advantages of a higher level of investment?

A
  • investment is an injection into the circular flow of income, it is a component of AD
  • new capital can boost productivity + creates additional capacity to supply
  • creates extra demand in investment goods industries + can lead to strong multiplier effects on the level of GDP
  • investment will boost a country’s competitiveness + therefore improve the trade balance
31
Q

what is government spending?

A

the total spending by the government in the economy

32
Q

why is the AD curve downward sloping?

A
  • real balance effect = as the price level rises, the value of real income falls and consumers can afford fewer goods and services
  • a persistent rise in the price level of a country could make foreign-produced goods and services cheaper, causing a fall in exports and a rise in imports, net exports would decrease and AD falls
  • if the price level rises, this causes inflation + an increase in demand for money + a possible rise in interest rates –> deflationary effect on consumer and business demand
33
Q

what causes a shift in the AD curve?

A

changes in the components of AD (C, I, G or X-M)

34
Q

what is real GDP?

A

the value of GDP adjusted for inflation

35
Q

what is nominal GDP?

A

the value of GDP without being adjusted for inflation

36
Q

how do you calculate GDP per capita?

A

GDP / population

37
Q

why is GDP per capita a good indicator of economic growth?

A
  • it measures the mean wealth of each citizen in a country
  • makes it easier to compare standards of living between countries
38
Q

explain what the multiplier effect is

A

an injection into the circular flow of income leads to a more than proportionate increase in economic growth

39
Q

what does MPC stand for?

A

marginal propensity to consume

40
Q

what is MPC?

A

proportion of additional income that is spent on consumption of goods and services

41
Q

how do you calculate MPC?

A

change in consumption/change in income

42
Q

how do you calculate the multiplier?

A

1 / 1- MPC

43
Q

what determines the size of the multiplier?

A
  • interest rates
  • consumer confidence
  • income levels (low vs high income households)
  • marginal tax rates
  • marginal propensity to import, exchange rate or price of foreign goods and services
44
Q

what is aggregate supply?

A

the total amount of goods and services produced in an economy at a given price over a period of time

45
Q

why is the SRAS curve upward sloping?

A
  • higher prices for goods and services make output more profitable
  • enable businesses to expand their production
46
Q

what causes shifts in the SRAS curve?

A

costs of production:
- worker’s wages
- raw materials
- import prices
- taxes on firms

47
Q

what causes shifts in the LRAS curve?

A

changes in the quality and quantity of factors of production of an economy

48
Q

what does the acronym SPICED stand for?

A

strong pound, imports cheaper, exports dearer

49
Q

what determines how much is exported and imported?

A
  • exchange rates
  • domestic + global economic growth rates
  • degree of protectionism (e.g. tariffs or quotas)
  • domestic inflation
  • quality of imports/exports
50
Q

what is inflation?

A

the sustained increase in the average price level

51
Q

what is deflation?

A

the sustained fall in the average price level

52
Q

what is disinflation?

A

the sustained slowdown in the increase of the average price level

53
Q

what are the two types of inflation?

A

demand-pull and cost-push

54
Q

what is stagflation?

A

high inflation and high unemployment

55
Q

what is the balance of payments?

A

a record of the flow of money between a country and the rest of the world
- it is made up of the current account and capital account (which includes the financial account)

56
Q

what are imports?

A

goods and services entering a country

57
Q

what are exports?

A

goods and services leaving a country

58
Q

what does a current account surplus mean?

A

greater monetary inflows from abroad than outflows

59
Q

what does a current account deficit mean?

A

greater monetary outflows from domestic households, firms and government than inflows

60
Q

what makes up the current account?

A
  • trade in goods
  • trade in services
  • net investment
  • net transfers
61
Q

what are the two main tools of monetary policy?

A
  • bank (base) rate
  • quantitative easing
62
Q

what is quantitative easing?

A

the purchasing of bonds in order to provide liquidity to private banks

63
Q

how do interest rates affect the exchange rate?

A
  • higher interest rates increase the value of a country’s currency
  • higher interest rates tend to attract foreign investment, increasing the demand for and value of the home country’s currency
64
Q

what is forward guidance?

A

providing information about the central banks’ future monetary policy

65
Q

what are the factors considered by the MPC when setting the base rate?

A
  • unemployment rate
  • savings rate
  • consumer spending
  • high commodity prices
  • exchange rate
66
Q
A

macroeconomics (7 decks)

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