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Freakonomics (macro) > How the macroeconomy works > Flashcards

How the macroeconomy works Flashcards

1
Q

What is the circular flow of income

A

An economic model showing flow of goods and services, factors of production and payments between households and firms within a closed economy

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2
Q

What is the monetary (outer) flow from firms to households

A

Income

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3
Q

What is the non-monetary (inner) flow from firms to households

A

Goods and services

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4
Q

What is the monetary (outer) flow from households to firms

A

Expenditure (on goods and services)

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5
Q

What is the non monetary (inner) flow from households to firms

A

Factors of production

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6
Q

What are the 3 ways of measuring economic activity

A

-National output (O)
-National expenditure (E)
-National income (Y)

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7
Q

What is national output (O)

A

The value of the flow of goods from firms to households

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8
Q

What is National expenditure (E)

A

The value of spending by households on goods and services

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9
Q

What is national income (Y)

A

The value of income paid by firms to households in return for land, labour and capital

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10
Q

What are the assumptions of the model (Flow of income)

A
  • Households spend all their income on goods and services
  • Firms spend all their income on factors of production
  • There is no foreign trade
  • There is no government
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11
Q

What are injections

A

Additions of money into the circular flow

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12
Q

Examples of injections

A
  • Exports (X)
  • Investment (I)
  • Govt spending (G)
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13
Q

What are withdrawals

A

Removal of money from the circular flow

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14
Q

Examples of withdrawals

A
  • Imports (M)
  • Taxation (T)
  • Savings (S)
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15
Q

What happens if injections>withdrawals?

A
  • Growth
  • Expenditure will exceed planned level of output = firms will increase output = output and national income increase = expenditure will increase
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16
Q

What happens if withdrawals>injections?

A
  • Contraction
  • Output will exceed expenditure = firms will reduce output = national income and expenditure will decrease
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17
Q

What happens when withdrawals=Injections

A
  • Macroeconomic equilibrium
  • no tendency to change- economy stays same size
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18
Q

When does disequilibrium occur

A

When the plans of firms and households differ

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19
Q

What is Aggregate demand

A

Total spendings of goods and services in an economy over a period of time

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20
Q

AD =

A

Consumption + nvestment + Govt spending + (Exports-imports )

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21
Q

What is consumption (C)

A

Spending on goods and services

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22
Q

What is investment (I)

A

Investment spending on assets used over a number of years to produce goods and services (private sector investment)

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23
Q

What is govt spending (G)

A

Spending on publicly provided goods and services

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24
Q

What are exports (X)

A

Uk output sold abroad

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25
Q

What are imports (M)

A

Foreign output purchased by UK

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26
Q

Approx % of factors of aggregate demand in UK

A

Consumption – 61%
Investment – 15%
Govt spending – 25%
Exports – -1%

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27
Q

What does Consumption being the largest factor of AD in the UK mean

A

An increase in consumption would have a much bigger impact than an increase in other components

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28
Q

X axis for AD curve

A

Real national output

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29
Q

Y axis for AD curve

A

Price level- avg price for all goods and services in an economy

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30
Q

Why is AD curve downwards sloping

A
  • At higher prices, total demand decreases
  • As price level increases, Uk goods less competitive so X decrease, M increases
  • As price level rises, real value of incomes fall (real balance effect)
  • As price level rises, Bank of England raise interest rate, reducing consumption and investment
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31
Q

What causes shifts in AD curve

A

Changes in components of AD (C,I,G,X,M)

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32
Q

What causes movement along AD curve

A

Changes in price level

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33
Q

What does a rise in price level lead to

A

Contraction in aggregate demand

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34
Q

What does a fall in price level lead to

A

Expansion in aggregate demand

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35
Q

What does an increase in components of AD lead to

A

Right shift

36
Q

What does a decrease in components of AD lead to

A

Left shift

37
Q

What is marginal propensity to consume (MPC)

A

The amount of an increase in earnings that is spent

38
Q

What is marginal propensity to save (MPS)

A

The amount of an increase in earnings that is saved

39
Q

What is Average propensity to consume (APC)

A

The total proportion of income that is spent (Consumption/income)

40
Q

What is Average propensity to save (APS)

A

Total proportion of income that is saved

41
Q

What affects Disposable income and spending

A
  • MPC
  • MPS
  • APC
  • APS
  • Consumer confidence
  • Interest rates and supply of credit
  • Distribution of income
  • Actual changes in economy e.g. changes in house prices
42
Q

What effects consumer confidence

A
  • Employment security
  • real disposable income
  • household wealth
43
Q

What is marginal efficiency of Capital (MEC)

A

The expected return on an investment at a given time

44
Q

What factors effect levels of investment

A
  • Actual and expected demand (govt policy)
  • Demand for Exports
  • Interest rates- low=less risk
  • Risk
  • MEC
  • Technological change and competitiveness
  • Business confidence
  • Bank willingness to lend
  • Govt policy- NIC tax increase= confidence decrease
  • Accelerator effect
45
Q

What does Keynes ‘animal spirits’ theory highlight

A

The importance of confidence and gut instinct of business people in making decisions

46
Q

Why is investment so important

A
  • Creates demand
  • increases productive potential
  • improves competitiveness and productivity
  • long term growth- ‘spend to grow’
47
Q

What is crowding out

A

A situation where increased govt spending or borrowing leads to a reduction in private sector investment due to high interest rates of limited available capital

48
Q

What is the accelerator effect

A

When an increase in National income results in proportionally larger change in investment ie people invest at a greater rate than initial growth

49
Q

What is net trade

50
Q

What affects net trade

A
  • Level of real income
  • Exchange rate (SPICED, WPIDEC)
  • Quality and other non-price factors
  • Economic performance of other countries
  • Protectionism/isolationism - Trump/USA, Tariffs on China
51
Q

Examples of demand side shocks, causing sudden large changes in AD

A
  • Recession in one or more trading partners
  • Large rise of fall in exchange rate
  • Housing market slumps
  • Share price collapse
  • Events e.g. financial crisis, covid etc
  • Unexpected rise or fall in interest rates and tax
52
Q

What does SPICED stand for

A

Stronger Pound Imports Cheaper Exports dearer
(dearer=more expensive)

53
Q

What does WPIDEC stand for

A

Weaker Pound Imports Dearer Exports Cheaper
(Dearer=more expensive)

54
Q

What is the multiplier effect

A
  • An initial injection into the economy resulting in a more than proportional increase in national income
55
Q

How is size of multiplier based

A
  • Based on how much an extra £1 injected will be re-spent in the economy (MPC) and any money not spent is leaked and doesn’t go around the cycle again
56
Q

The larger the multiplier….

A

…the larger the effect on the economy of an injection

57
Q

What are examples of leakages in an economy

A
  • Savings
  • Taxes
  • Imports
58
Q

What is MPW

A

Marginal propensity to withdraw

59
Q

What is MPW made up of

A
  • MPS
  • MPT
  • MPM
60
Q

What is MPT

A

Marginal propensity to tax- proportion of an income taken in tax

61
Q

What is MPM

A

Marginal propensity to import- proportion of an increase in income spent on imports

62
Q

MPW=

A

MPS+MPT+MPM

63
Q

How to calculate the multiplier

A
  • 1/1-MPC
    OR
  • 1/MPW=1/MPS+MPT+MPM
64
Q

Factors effecting size of Multiplier

A
  • Interest rates
  • Tax rates
  • Imports
  • Spare capacity
  • Confidence
  • Income levels
65
Q

How do interest rates affect size of multiplier

A
  • If interest rates are high, consumption may not rise significantly as additional income may be saved rather than spent- withdrawal
66
Q

How do tax rates affect size of multiplier

A
  • Taxes are a withdrawal from the circular flow, and so if they are high consumers have less disposable income to consume goods and services
67
Q

How do imports effect the size of multiplier

A
  • If increases in disposable incomes are spent on imports this would count as a withdrawal
68
Q

How does spare capacity effect size of the multiplier

A
  • If there is very little spare capacity (unused resources) in the economy, then any increase in aggregate demand may not be able to be met by firms- therefore multiplier limited
69
Q

How does confidence affect size of multiplier

A
  • If confidence is higher, people encouraged to spend, so MPC may rise
70
Q

How does income levels affect size of multiplier

A
  • If individuals have low incomes, then any increase in income is likely to be spent, so they tend to have a higher MPC and vice versa
71
Q

What does short term mean

A
  • The period of time in which at least one factor of production is fixed
72
Q

What is long run in economics

A
  • The period of time in which all factors of production are variable
73
Q

What is Short term aggregate supply (SRAS)

A

The amount that will be supplied when at least one factor of production is fixed

74
Q

What is Long run aggregate supply (LRAS)

A

The amount that will be supplied when all factors of production are variable, equivalent to productive potential of an economy

75
Q

What is aggregate supply

A

The total value of output in the economy at a given price level at a given point in time

76
Q

Why is the SRAS curve upwards sloping

A
  • Because price level in an economy will rise as firms increase output- remember some factors of production are fixed
77
Q

What do changes in aggregate demand lead to

A

movements along SRAS curve- if AD increases, firms hire more labour and make resources work harder to boost supply so they can increaser profits

78
Q

What factors cause a shift in SRAS

A

-Wages
-Raw materials
-Labour productivity
-Interest rates
-Changes to taxation rates affecting firms, subsidies and imported costs
-Supply shocks
-Tariffs and Quotas
-Price of commodities

79
Q

What do increase in C.O.P lead to

A

Left shift in SRAS

80
Q

What does decrease in C.O.P lead to

A

right shift in SRAS

81
Q

When is the LRAS curve vertical

A

At the level of productive potential of the economy

82
Q

What is the classical view of LRAS

A
  • The economy will always produce the maximum that its factor resources will allow
  • Markets will always function efficiently in the long run (producing outer boundary of ppf)
  • Wages and prices will be flexible and adjust to bring economy into equilibrium- no unemployment in long run, only temporary
  • LRAS curve is therefore vertical at productive capacity of economy
83
Q

What is the Keysian view of LRAS

A
  • The economy could be in equilibrium below full employment
  • markets take time to clear and you can get long periods of unemployment
    -wages are sticky downwards
    -negative multiplier effect
    -in recession, people lose confidence and save more
84
Q

When spare capacity is high, AS will be….

A

..elastic- a rise in AD can be met easily by increased output without inflation

85
Q

The elasticity of AS curve falls as..

A

..output increases because
-spare capacity declines
-diminishing returns in production
-resource shortages

86
Q

When AS becomes perfectly inelastic…

A

the economy is at full capacity

Freakonomics (macro) (5 decks)

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