How the Macroeconomy Works Flashcards
what is the definition for national income ?
the total number of goods and services a country produces every year
what is GNP ?
GDP + income earned overseas
what is GNI ?
sum of value added by all the producers
what is a withdrawal in the circular flow of income ?
money moving out of the economy
leakages of money out of the economy
what is an injection in the circular flow of income ?
money moving in the economy
new income in the economy
what are the main economic withdrawals in the circular flow of income ?
savings, by households
taxes, by government
imports
what are the main economic injections in the circular flow of income ?
investment
government spending (public & merit goods, welfare payments)
exports
what causes an equilibrium in the economy ?
withdrawals = the rate of injections
what is aggregate demand ?
total demand for all goods and services in the economy at a given time and price
why is the demand and aggregate demand curve downward sloping ?
as prices increases, the value of real incomes fall, so goods and services become less affordable.
higher inflation usually results in higher interest rates, discouraging investment and spending.
what are the components of AD ?
C + I + G + (X-M)
what causes a shift in AD ?
change to the components of AD
consumption
investment
government spending
exports
imports
what is AS (SRAS) ?
total supply of goods and services produced in the economy
only covers the period immediately after price level changes, whilst factors of production are kept constant.
why is the supply and aggregate supply curve upward sloping ?
higher prices, higher profits for firms, so they will supply more
what causes a shift in AS ?
changes in cost of production (FOP)
(cost of employment increases, costs of inputs e.g. raw materials increases, government regulation e.g. environmental law)
what is the economic short run definition ?
Price is variable, everything else is controlled
what is the economic long run definition ?
everything is variable including price
why is LRAS completely vertical ?
supply is unresponsive to a change in price
where is there an excess in supply ?
above the market equilibrium
where is there an excess in demand ?
below the market equilibrium
what influences consumer spending ?
interest rates
consumer confidence
influences on investment
business expectations
demand for exports
how does AD influence the level of economic activity ?
employment (production and consumption)
confidence
events (natural disasters)
tax, interest rates
what is the multiplier effect ?
when initial investment leads to greater investment which leads to economic growth
what are the stages of the multiplier effect ?
new demand in the economy
⬇
leading to a new injection of income in the economy
⬇
leading to economic growth
⬇
leading to more jobs, higher incomes, and greater spending
finish off the sentence,
“one persons spending …
… is another persons income.”
what are the axis on a basic MACRO supply and demand curve ?
price level Y
real GDP X
what is the main factors influencing/ causing shifts in SRAS ?
cost of production
(cost of employment, inputs, government regulation and laws)
what is the main factor influencing? causing shifts in LRAS ?
quality and quantity of production
why is the LRAS curve fixed vertically ?
- output is fixed (at each level)
- FOP are fully employed in the economy
- shifting AD only changes price, not output
what factors influence LRAS ?
- technology advancements (^qual, quan)
- productivity (^quan)
- education and training (^qual)
- government regulation (^quan)
- demographic/ migration (^quan)
- competition policy/ efficiency (^qual, quan)
what is the circular flow of income used to illustrate ?
the flow of money, resources, and goods in an economy
what is the financial sector in the circular flow of income made up of ?
investment
savings
what is the foreign sector in the circular flow of income made up of ?
exports
imports
if (injections > withdrawals) how will it affect the economy ?
economic growth
increase in national income
if (injections < withdrawals) how will it affect the economy ?
economic decline
decrease in national income
if there is an increase in interest rates how will it effect the circular flow of income ?
more and more households will save because the reward of saving is greater
saving is a withdrawal
this will decrease the relative size or the circular flow of income because, investment will fall due to a decrease in consumption
what does the determinant of savings depend on ?
an individuals/ or households decision to save money rather than consume it immediately
when savings decrease what tends to happen to consumption ?
consumption usually increases
when savings increase what tends to happen to consumption ?
consumption usually decreases
when the economy is booming what tends to happen to consumption ?
it increases
when the economy is slumping what tends to happen to consumption ?
it decreases
where is there an equilibrium at the national income level ?
injections = withdrawals
what are net exports ?
the difference (profit) between the revenue grained from selling goods and the expenditure from goods abroad
what relationship does AD and AS/ SRAS show ?
the relationship between average price level and real GDP (total output)
if disposable income increases what happens to consumption ?
increases
if disposable income decreases what happens to consumption ?
decreases
what factors cause a change in the level of consumption ?
interest rates (spend or save)
consumer confidence (strong or weak economy)
change in wealth/ income
what factors cause a change in the level of consumption ?
interest rates (cheap or expensive to loan/ borrow)
business confidence
government intervention (subsidies, increase inv indirect tax, decrease inv)
demand for exports
what factors influence government spending ?
economic cycle (G will spend more in recession to stimulate inflation)
political decisions
what factors impact the level of exports ?
level of income abroad
domestic inflation rate
value of the pound (price of imports for foreigners are less expensive if the pound is weak)
what factors effect the level of imports ?
level of income domestically
value of pound (price of imports for us will be less expensive if the pound is strong)
where does the short run macroeconomic equilibrium occur ?
where aggregate demand (AD) intersects with short-run aggregate supply (SRAS)
what do the free-market economists believe about capacity in the long run ?
In the long-run, the economy will return to this normal capacity level of output
where does the long-run macroeconomic equilibrium occur ?
the intersection of long-run aggregate supply (LRAS), short-run aggregate supply (SRAS) & aggregate demand (AD)
what is an economic shock ?
an unpredictable event that has macroeconomic consequences
what is a demand-side shock ?
typically involves a sudden change in the levels of private spending, as seen in shifts in consumer spending or business investment
what is a supply-side shock ?
When production across an economy is made more difficult
in detail, what are the step by step consequences of an injection into the economy ?
1) the AD curve will shift to the right
2) This increases the overall level of real output
3) When real output increases, firms typically need to hire additional workers to meet the higher demand for goods/services
4) The increased employment is linked to an increase in economic growth
in detail, what are the step by step consequences of a withdrawal into the economy ?
1) the AD curve will shift to the left
2)This decreases the overall level of real output
3) When real output decreases, firms typically reduce their workforce to align with reduced demand for goods/services
4) The decreased employment is linked to a decrease in economic growth
what is the multiplier effect ?
states that any injection in the economy leads to a greater impact on the economy than the value of the initial injection
what effect does the marginal propensity to consume (MPC) have on the multiplier effect ?
The higher the leakages, the smaller the marginal propensity to consume (MPC)
The higher the marginal propensity to consume, the lower the leakages and the greater the multiplier will be
what is the definition of MPC ?
the proportion of additional income that is spent on consumption
what is the formula for MPC ?
change in consumption
/ change in income
what is the formula for working out the value of the multiplier ?
1/ (1-MPC)
the greater the MPC the … ?
the higher the multiplier
the smaller the MPC the … ?
the lower the multiplier
what is the accelerator ?
increases in r.gdp due to initial AD from multiplier, encourage firms to invest further due to greater confidence in the economy.
- As economy expands, firms invest more into capital goods
- As economy contracts, firms invest less into capital goods
how does the multiplier and the accelerator effect work together ?
1) As the demand for goods and services increase, AD increases
2) As a result, firms invest more (or make an accelerated investment) into capital goods to meet demand for products in the hope of making
a profit
3) This leads to a further increase in AD
4) This increase in AD is then multiplied, making growth in national income more rapid
5) Which leads to an even more accelerated investment into capital goods by firms
The multiplier process is based on the idea that …
one persons spending is another persons income
how do Firm and Households interact and exchange resources in an economy ?
Households:
supply firms with factors of production (labour & capital) and in return they receive wages and dividends
Firms:
supply goods and services to households. consumers pay a price for these.
what is the equation that is critical to remember for the circular flow of income ?
income = output = expenditure
what will happen if there a net injections into the economy (injection > withdrawals) ?
there will be an expansion of national output.
what will happen if there are net withdrawals from the economy (withdrawals > injections) ?
there will be a contraction of production, so output decreases.
what is the wealth effect ?
a rise in price of houses makes people feel wealthier, so they spend more.
what is LRAS curve ?
shows the productive potential of an economy in the long run.
what does a right-ward or expansion in LRAS show ?
economic growth
where is a macroeconomic equilibrium reached ?
where AD=AS
what does an right-ward shift or an outward or expansion in SRAS show ?
economy is more productive, there is an increase in efficiency, lowering average price level.
what is disposable income ?
the amount of income consumers have left over after taxes and social security charges have been removed.
what is MPS (marginal propensity to save) ?
the additional income earned by households that they choose to save.
what determines consumer confidence ?
return on investment
fear of unemployment
tax
what are the 2 variables influenced in Fiscal Policy ?
government spending
taxation
what is fiscal policy ?
demand-side policy
what are automatic stabilisers ?
policies which offset fluctuations in the economy.
they are triggered without government intervention.
if economic growth falls, gov spending automatically increases, and taxation falls
how do you work out the value of the current account ?
exports - imports
what is protectionism ?
the act of guarding a countries industries from foreign competition, through tarrifs, quotas, and embargos.
what is one way the effects of the multiplier can be measured ?
The Multiplier Effect:
a rise in national income : initial rise in AD
how does the elasticity of SRAS influence the multiplier effect ?
If an economy has a lot of spare capacity, extra output can be produced quickly and
at little extra cost. This makes SRAS elastic and it means the size of the multiplier will
be larger. A small increase in AD will lead to a large increase in national income.
how do you calculate the multiplier ?
1 / (1-MPC)
what does the keynasian LRAS curve suggest ?
. price level in the economy is fixed until resources are fully employed
. the flat part represents (spare capacity), thats why output can be increased over that part of the LRAS curve without influencing price.
once resources are fully employed, inflation can occur when AD shifts
