How The Macro Economy Works Flashcards
What is national income?
National income is the total value of goods and services a country produces. It is the output per year.
How can national income be measured?
GDP
GNP
GNI
What is real GDP?
Is the value of GDP adjusted for inflation. For example if the economy grew by 4% last year but inflation was 2% then real economic growth is 2%.
What is nominal GDP?
Is the value of GDP that hasn’t been adjusted for inflation. It is misleading as it can make economic growth appear higher.
What is GNP?
Is the market value of all products produced in an annum by the labour and property supplied by the citizens of one country. It includes GDP plus income earned from overseas assets minus income earned by overseas residents.
GDP is within a countries borders whilst GNP includes products produced by citizens of a country whether inside a border or not
What is GNI?
The sum of value added by all producers who reside in a nation plus those who produce taxes
Name 3 withdrawals
1) Taxation
2) Saving
3) Imports
Name 3 injections
Exports
Investment
Government expenditure
In the circular flow of income, income equals
Income = expenditure =output
What is an injection
An injection is from the circular flow of income where money enters an economy, this is in the form of GS, tax and, exports
What is a withdrawal?
A withdrawal in the circular flow of income is when money leaves the economy. This can be from taxes, imports and savings.
When does the economy reach equilibrium in terms of circular flow of income
When the rate of withdrawals = the rate of injections
What happens in an economy if there is net injections?
Expansion of national output
What happens in an economy if there is net withdrawals
Contraction of production so output decreases
What is aggregate demand?
Aggregate demand is the total demand in an economy.
It measures spending on goods and services by consumers, firms, government and overseas people.
Calculation for AD
AD= C + I + G + (X - M)
Name the factors that affect AD.
Consumer spending
Investment
Government expenditure
Net balances
What is consumer spending?
How much consumers spend on goods and services
It is the largest component of AD therefore the most significant to economic growth
It makes up 60% of GDP
What does consumer income come from?
Wages
Savings
Pension
Benefits
Investment
What is a consumers marginal prosperity to consume?
How much a consumer changes their spending when their income changes
What is a consumers marginal prosperity to save?
The porporino of each additional pound of a households income that is used for saving
What does the consumer marginal to prosperity added to consumer marginal prosperity to save equal too?
1
Name the parts that influence consumer spending?
Interest rates
Consumer confidence
How does interest rates influence consumer spending.
If monetary policy reduced interest rates, consumers would have less incentive to save and more incentive to invest and spend.
Lower interest rates also reduce debt which makes mortgages easier so consumers have more disposable income.
Why might using interest rates to boost consumer spending be limited?
There is time lags, so it’s not suitable if AD needed to rise immediately.
How does consumer confidence affect consumer spending?
Consumers and firms have higher confidence so they invest and spend more as they feel there will be a high return on their investment
This is affected by anticipated income and inflation.
On the flip side, if consumer confidence is low than people hold off on investments and big purchases which boost up GDP and AD as they feel skeptical and more comfortable saving
What is capital investment relating to AD
This accounts for 20% of GDP
About 3/4 comes from private sectors
Name the things that influence investment
Interest rates
Economic growth
Business expectations and confidence
Demand for exports
Access to credit
Influence of government regulations
How does economic growth impact investment
If growth is high, than governments have more revenue from consumer spending , which in turn leads to more profit that can be invested
How does business expectations and confidence influence investment
If firms expect a high rate of return then they will invest more, firms need to be certain of their future or they will just postpone events .
Expectations about society and politics influences investment, an example if governments were to change than taxes may rise and therefore investments will be postponed
How does demand for exports influence investment
Linked to the rate of market demand, if demand is high firms will be more likely to invest .
This is because they expect higher sales therefore they direct capital goods into a market where export demand is high and consumer demand is increasing.
How does interest rates influence investment
Investment increases as interest rates fall, as cost to borrow is cheap and amount to pay back is low.
The higher interest rates are the higher opportunity cost for saving is
As well, higher interest rates means businesses assume consumers won’t spend as much which leads to them postponing investment
How does access to credit influence investment?
If banks are unwilling to lend for example after a financial crisis where banks become more adverse, firms will find it harder to gain access to credit making it either too expensive or not possible to get loans.
Firms could use retained profit however.
The availability of loans is based on the amount of savings, the more consumers save the more money available to loan therefore invest.
How does governments and regulations influence investment
The rate of corporation tax
What is the accelerator effect.
The level of investment in an economy is related to the change in GDP. A higher rate of economic growth leads to more investment.
If the rate of economic growth is slowing but economic growth is still growing investment may still fall .
What is government spending
How much the government spends on state goods and services such as NHS
Account for 20%
Names the influences on government expenditure
Trade cycle
Fiscal policy
How does trade cycle affect government spending
It refers to the stage of economic growth that an economy is in like booms or busts
During periods of recession,governments may increase their spending to stimulate growth, however this increases budget deficits
During periods of economic growth, governments may receive more tax money therefore they may decide to spend less as the economy is doing fine
How does fiscal policy affect government spending
Fiscal policy influences use economy as governments change spending and taxation
Fiscal policy is a demand side policy so it influences AD
The government may use expansionary fiscal policy during times of economic decline, this involves boosting AD
Contractionary fiscal policy is used during economic growth to increase taxes
What is exports minus imports
The value of current account on the balance of payments.
A positive value indicates a surplus whilst a negative value indicates a deficit.
The uk has a bad trade deficit which reduces AD, this is the second largest component of AD
What factors influence exports - imports
Real income
State of world economy
Exchange rates
Degree of protectionism
Non price factors
How does exchange rates influence trade balance
A depreciation of the pound means that imports are more expensive and export are cheaper which narrows the trade deficit.
Depreciation makes the currency more competitive against other nations .
However, it depends on the currency compared with, if we do not trade with a certain currency that often it has less value than the likes of the euro or dollar .
More importantly, the demand for UK export has to be Price elastic as if it is in elastic export will not increase significantly.
How does real income affect trade balance
During periods of economic growth when consumers have more income, they can afford to spend more, there is a larger deficit on the current account
This is because consumers can now afford to spend more on imports therefore historically that current balance has improved when the UK is in an economic decline.
How does state of the world economy affect trade balance
If there is a decline in economic growth in our markets abroad, then there will be less exports as these economies have less real income to spend on our export.
How does the degree of protectionism affect trade balance?
Protectionism is the act of protecting industries from foreign competition. This can be in the form of tariffs quotes and regulations.
If an economy has more trade protectionism then there will be a decrease in trade deficit as people will find it harder and more expensive to import. Consequently decreasing imports
However, there is issues as exports may also decrease from this therefore not improving trade balance .
How does non price factors influence trade balance
The competitiveness of a countries goods and services which is influenced by supply side policies, impacts the export of a country.
A country can become competitive by being more innovative, producing high-quality products, Operating in a niche market, having low labour costs and being more productive this all increases exports.
Similarly, trade deals massively influence exports.
Name the ways AD increases economic activity
Employment (production and consumption)
Confidence (spending and investment)
Events (natural disasters)
Other factors (taxes / interest rates influence borrowing and spending)
Explain the multiplier effect?
It occurs when those new demand in an economy, which leads to an injection of income into the circular flow of income which leads to more economic growth. This leads to more jobs being created, higher average incomes and therefore more spending.
The multiplier effect refers to how an initial growth in AD leads to an overall growth in national income.
What is the multiplier ratio?
It is the ratio of the rise of national income to the rise in initial AD.
What is the significance of the multiplier to shifts in AD in the case of an elastic SRAS.
If an economy has a lot of spare capacity, production can increase quickly and at little extra cost. This makes SRAS elastic and the size of the multiplier larger.
A small increase in AD will lead to a larger increase in national income
What is the significance of the multiplier to shifts in AD in the case of an inelastic SRAS.
If SRAS is inelastic the multiplier effect will be smaller than its potential. This is because if AD increases prices will increase rather than national income increasing. This higher rate of inflation will lead to higher interest rates. In consequence this will increase the desire to save rather than spend.
What is a reverse multiplier
This is when a withdrawal of income could lead to a decrease in the circle of flow of income. This could lead to an even larger decrease in the income for an economy. This could decrease economic growth and potentially lead to decline in the economy.
Name the factors that influence SRAS.
It shifts when they are changes in the condition of supply.
Price level and production costs are the main factors. For example, the cost of employment might change, for example minimum wage ,higher taxes etc. that there is the cost of other inputs like raw material and exchange rates.
Then there is government regulations such as environmental policies, there could be a net outward of migration workers where all educated people leave the country to be paid better somewhere else.
What is the LRAS curve shaped like
Vertical
This view comes from the idea that output at each level is fixed as all factors of production are being used fully in the long run.
Meaning that changing AD will only change the price level and not the real output level.
Name the factors affecting LRAS
Technology advances
Changes in relative productivity
Changes in education and skills
Changes in regulations
Democratic changes in migration
Competition policy
How does technology advancements affect LRAS
If money is put into technological advancements, then goods and services can be produced faster and a higher quality rate.
How does affect changes in relative productivity LRAS
A more productive labour and capital input will produce more output with the same original input.
How does changes in education and skills affect LRAS
This improves the quality of human capital which allows for a wider range of output to be created as they’re more productive
How does changes in government regulations affect LRAS
Government regulations can limit how productive the potential of firms can be if they are too excessive.
How does demographic changes and migration affect LRAS
If there is a net inward of migration and majority of the population are of working age that means that more output can be produced.
How does competition policy affect LRAS
A more competitive marketing encourages firms to be more efficient and competitive as they don’t want to lose their spot in the market. Governments can use effective competition policies to stimulate the economy.
How can a downward fall in the AD curve be explained
Higher prices lead to a fall in real income value, meaning things become unaffordable
If there was high inflation in the uk then forgien good (imports) are more used. Therefore the deficit on the account would occur and Ad will fall
High inflation means borrowing is expensive which reduces borrowing and therefore investment
Why does AD shift
Due to changes in c + I + g + x-m
What causes a rightward shift in AD
High confidence levels, more investment
Monetary Policy committe lowers inflation by than saving is less valued
Lower taxes more consumer spending
An increase in government spending
Depreciation in the currency so imports are expensive means that the balance of payments is balanced.
House prices rising means people feel wealthier which increases spending, due to wealth effect
Credit becoming available
How does the AS curve move
Due to changes in price levels which comes from changes in AD which leads to movement on AS curve.
If AD increase then there’s expansionary movement whilst AD decreasing leads to contractionary
What is macroeconomic equilibrium
When the economy reaches a state of equilibrium when the rate of withdrawals = the rate of injections. Or when ad = as
What happens at the equilibrium point
Below the equilibrium is when there is excess aggregate demand
Above equilibrium is when there is excess aggregate supply
This applies to short run
Brief explanation of AS shifts
An inward shift means that prices increase and national output decreases
If the economy becomes more productive and there’s an increases in efficiency supply will shift rightward, meaning prices decrease and national output increases.
