How the macroeconomy works

Question 1

What is national income and what does it measure ?

Answer 1

Total of earnings by businesses and people. To produce the flow of national output there needs to be physical and human capital with land and entrepreneurship.
Note:
GDP does not take into account national trading but GNI does.

Question 2

What are national capital stock and national wealth ?

Answer 2

National capital stock is part of national wealth which is all the physical assets owned by the residents

Question 3

How does national output, income and expenditure measure flow of output in different ways ?

Answer 3

1. NO: measure the goods and services produced by an economy.
   2.NI: measures income received by labour when producing goods and services.
   3.NE: measures the spending of incomes on these goods and services.
   Therefore:
   NI=NO=NE

Question 4

What is the circular flow of income ?

Answer 4

It is a model of closed economy ( with no international trade and government ). The only agents are households and firms. Households supply labour and firms provide income. Look at figure 7.2 pg 163

Question 5

What is the more realistic version of the circular flow of income ?

Answer 5

It is where there are injections and withdrawals in an open economy ( there is international trade )

Question 6

What are injections ?

Answer 6

Spending entering the circular flow of income:
1. Gov spending
2. Exports
3. Investment - total planned spending by firms on capital goods produced in the economy.

Question 7

What are withdrawals ?

Answer 7

A leakage of spending power out of CFI:
1.Taxations
2.Imports
3. Saving - income that is not spent

Question 8

What determines the equilibrium of national income ?

Answer 8

1. If injections < withdrawals then output and income falls.
2. If injections > withdrawals then output and income rise
3. If injections = withdrawals then national income is in equilibrium

Question 9

What is the difference between lent and hoarded savings ?

Answer 9

Savings are lent via financial intermediaries e.g banks so it may equal investment meaning there is an equilibrium.

Question 10

What are reflationary policies ?

Answer 10

policies that increase AD with intention of increasing real output and employment

Question 11

What is equilibrium national income ?

Answer 11

Level of output at which AD=AS

Question 12

What is AD ?

Answer 12

Total planned spending on real output produced within the economy

Question 13

What is AS ?

Answer 13

Level of real national output that producers are prepared to supply at a given price

Question 14

What is the other way of expressing changes in equilibrium using a graph ?

Answer 14

Using the AD / AS diagrams where curves shift inward or outward

Question 15

What is an economic shock ?

Answer 15

An unexpected event hitting the economy they can be either demand or supply side shocks

Question 16

What is an example of an economic shock for the UK ?

Answer 16

The outbreak of war in the Middle East affecting consumer confidence (demand) and price of crude (supply

Question 17

What are the components of AD ?

Answer 17

AD= C + I + G + (X-M)
Note:
Spending on UK exports minus spending on imports by UK residents
Consumption accounts for 65%

Question 18

What is consumption ?

Answer 18

It is the spending by all households in the economy on goods and services of a country.

Question 19

What is a credit crunch ?

Answer 19

When there is a lack of funds available in credit markets leading to increased interest rates.

Question 20

What affects consumption ?

Answer 20

1. Interest rates - the greater the rates the greater the reward for saving so saving increases and consumption falls.
2. Level of income - as income increases absolute consumption rises but consumption falls as a fraction of total income while the fraction saved increases.

3.Consumer confidence - when it is high people spend more and when it is low people spend less. That is why governments boost consumer confidence regularly.

4. Availability of credit - when credit is available easily and cheaply consumption increases.
5. Distribution of income - Redistributing of income from rich to poor increases consumption because poor people have a higher MPC.

Question 21

How do you calculate the personal saving ratio ?

Answer 21

Personal saving ratio = realised or actual personal saving / personal disposable income.

It is used by governments to see how much people are planning to save of their income.

Question 22

What is the difference between saving and investment ?

Answer 22

Saving is income that is not spent on consumption where as investment is spending by firms on capital goods e.g machinery

Question 23

What are factors the influence investment decisions ?

Answer 23

1. Expected future sales revenue from the investment project.
2. Expected future costs of production.
3. Expected profit yield from the investment in the future.
4. Interest rates.
5. Relative prices of capital and labour.
6. Nature of technological progress - making things obsolete.
7. Availability of investment funds.
8. Impact of government policies and activities by investment by the private sector.

Question 24

What is the accelerator theory of investment ?

Answer 24

It is when there is economic growth acceleration investment expenditure increases and the opposite happens.

If national output grows by a constant amount each year, firms invest the same amount of new capital each year to enlarge their capital stock and maintain the desired capital - output ratio.

Question 25

What is the national income multiplier ?

Answer 25

The relationship between a change in AD and the resulting usually larger change in national income.

Question 26

How do you calculate the multiplier and represent it graphically ?

Answer 26

1. multiplier = change in NI / initial change in gov spending. ( it is used by multiplying the multiplier with gov spending )
2. The initial change in gov spending shifts the AD curve but then the multiplier effect pushes the curve further to the right. ( look at fig 7.10 pg178

Question 27

What are the other multipliers ?

Answer 27

There is a multiplier for each of the AD components: the tax and the gov spending multipliers are the fiscal policy multipliers.

Note:
Tax and import multipliers are negative because an increase in them leads to a fall in national income.

Question 28

What is Marginal propensity to consume and how is it the multiplier calculated ?

Answer 28

Fraction of an in increase in disposable income that people plan to spend on domestic goods. ( consumption multiplier )

K = 1/1-MPC

It is used by multiplying the multiplier (k) with change in AD e.g 10bn gov spending

Question 29

What is the difference between SRAS and LRAS ?

Answer 29

1. SRAS: is the AS when the level of capital is fixed and through the utilisation of idle resources it can change the level of real output. (upward sloping curve )

2.LRAS: AS when the economy is preforming at its production potential and if productivity rises the LRAS shifts to the right. ( vertical line)

Question 30

What is the assumption of upward slopping SRAS curve ?

Answer 30

1. Firms aim to maximise profits.
2. In short run cost of producing an extra unit increases as firms increase production.

Question 31

What factors shift the SRAS to the right ?

Answer 31

1.A fall in business costs of production
2. A fall in unit labour costs from increases labour productivity or fall in wage costs
3.Reduction in indirect taxes e.g VAT
4.Increase in government subsidies
5.Technoligical progress

Note:
SRAS depends on Price level

Question 32

What are the determinants of LRAS ?

Answer 32

1. Tech progress
   2.Quantity of factors of production in the economy
   3.Mobility of factors of production - labour
   4.Productivity of factors of production - labour productivity
   5.Personal enterprise
   6.Institutional structure of the economy

Question 33

What does the position of the LRAS mean ?

Answer 33

The normal capacity level of the economy