How The Macroeconomy Works Flashcards
consumption
spending by households on goods and services
investment
spending by businesses on additions to the capital stock
nominal national income
nation income unadjusted for changes in prices
real national income
removes the effect of price changes from the value of national income
Uses of real national income
- measure of how successful the economy is
- how well of the population is
- allows gov to estimate how much can be collected in taxation
circular flow of income
a model of the economy where income and spending flow between household and firms
injections
- gov spending
- exports
- investment
withdrawals
- taxation
- imports
- savings
when does national income increase
injections > withdrawals
when does national income decrease
withdrawals > injections
Aggregate demand
the total spending goods and services in an economy over a given period of time
equation of AD
consumption + investment + government spending + net exports (x-m)
Why is AD downward sloping?
- at lower price levels, the value of any assets increases in real terms, may lead to wealth effect (consumption increases)
- at lower price levels, increase exports because more price competitive
wealth effect?
increases in the value of household’s assets cause people to feel wealthier and encourages spending
wealth
the value of the assets held by households
Factors affecting consumption
1) Income
2) Interest rates
3) consumer confidence
4) wealth effects
5) taxes
6) unemploymetn
Link between consumption and investmnet
- consumption should increase profits for firms
- boost to business confidence, investment less risky
Accelerator theory
when there is an increase in national income GDP, there tends to be a proportionately greater increase in capital investment spending
if growth in national income increase?
firms will need a larger productive capacity in order to produce a higher level of output to meet the higher level of spending in the economy
industry where demand is growing rapidly?
- firms expand productive capacity
- deplete current stock of finished goods
- if its expected increase in demand will be sustained, firms may invest in more machines and factories
- may also invest in new technology, increase supply capacity
- causes accelerator effect
The multiplier effect
when an initial change in injections / withdrawals to the circular flow of income leads to a greater final change in real GDP
What is the the multiplier given by?
1/ (MP to save + MP to import + MP to tax)
why is multiplier effect given by this?
- due to injections of new demand for goods and services into the circular flow of income
- leads to further cycles of spending
- leads to bigger, cumulative effect on total levels of national output and employment
what happens if the economy is operating at or near full capacity
the multiplier effect can cause inflation
size of multiplier
1/ 1 - MPC
MPC
the proportion of any additional income that is spent and passed on around the circular flow of income
A rise in the prices level causes output to fall because
- domestic consumption reduced, things more expenisve
- demand for exports reduced
- imports rises if abroad is cheaper
Aggregate supply
the total output produced in an economy at a given price level over a given period of time
Shifts in short run AS
1) wage rates rise - left
2) changes in cost of raw materials, more expensive - left
3) productivity, rises - right
4) exchange rate, fall - left
Shifts in LRAS
increase in either quantity or quality of factors of production
Keynesian AS curve
- at low level of real GDP, easy for firm to find workers and utilise idle machinery and capacity
- as you get closer to maximum GDP, difficult to find more workers and spare capacity as upward pressure on wages and prices ( FOP become scarce)
- eventually becomes perfectly inelastic as you reach full employment
what are supply side policies for?
intended to increase long run trend rate of economic growth
economic shocks
sudden, unexpected events that affect the macroeconomy
demand side shocks
- unexpected changes in the level of aggregate demand
- affect the level of national income
supply side shocks
unexpected changes in the price or availability of factors of production
