How The Macroeconomy Works Flashcards
Factors that affect the level of economic activity?
Employment (production and consumption) Confidence (spending and investment) Events (Natural disasters or Christmas) Taxes Interest rates Influence how much firms and consumers borrow save or spend
When does the multiplier effect occur?
new demand in the economy Leading to an injection of more income into the circular flow Leads to economic growth Leads to more jobs Higher average income More spending More income
What does the multiplier effect refer to?
How an initial increase in AD leads to an even bigger increase in national income
What is the multiplier ratio?
Ratio of the rise national income to the rise in AD
What does the multiplier mean for AD?
If the economy has lots of spare capacity extra output can be produced quickly and at little extra cost
When will the multiplier be larger?
When SRAS is elastic
If SRAS is inelastic what happens when AD increases?
Prices will increase
Causing inflation
What is a reverse multiplier?
Withdrawal of income from the circular flow
Leads to decrease in economic growth
Economic decline
Define aggregate demand?
Total demand in an economy
Measures spending on goods and services by consumers firms the government and overseas customers and firms
Equation of aggregate demand?
C + I + G + (x-m)
What is disposable income?
The amount of income consumers have left over after taxes and social security changes have been removed
What is the largest component of AD?
Consumption (60%)
Where does consumer income come from?
Wages Savings Pensions Benefits Investments
What is a consumers marginal propensity to consume?
How much a consumer changed their spending following a change in income
How is consumption influenced by interest rates?
Cheaper to borrow
Reduced incentive to save
Spending and investment go up
Lower cost of debt increases disposable income
How is consumption influenced by consumer confidence (high)?
Invest and spend more
Feel they will get a higher return
Affected by anticipated income and inflation
How is consumption influenced by confidence (low)?
If consumers fear unemployment
Or high tax
They may feel less confident so spend less and save more
They delay large purchases
How is investment influenced by rate of economic growth?
If growth is high
Firms make more revenue due to higher consumer spending
More profits avsalible to invest
How is investment influenced by demand interest rates?
Investment increases when interest falls as borrowing costs less and return on lending is higher
What does an increase in interest rates mean for firms?
Greater opportunity cost of not saving money
Expect a fall in consumer spending
Discouraged investment
How is investment influenced by business expectations and confidence?
Of firms expect a higher rate of return they will invest more
How is investment influenced by government and regulations?
Rate of corporation tax affects investment
Low tax means firms keep more profits which encourages investment
How does the economic cycle influence government expenditure?
In recessions governments increase spending to stimulate the economy
E.g. Welfare payments cutting tax
Reasons for shift in AD curve?
Confidence Tax Interest rates Government spending Depreciation House prices
How do rising house prices shift the AD curve?
Rises in house prices make people who own houses feel wealthier
Wealth effect
How do lower tax levels shift the AD curve?
Lower taxes mean consumers have more disposable income
When consumers have higher confidence levels how does AD shift?
Firms and consumers invest and spend more
They feel as though they will get a higher return on them
This is affected by anticipated income and inflation
How does depreciation in currency shift the AD curve?
Imports are more expensive
Exports are cheaper
How does low interest rates shift AD curve?
Reduces incentive to save
Spending and investment increase
Time lags in this
Why is aggregate supply upward sloping?
Higher price level
Producers are willing to supply
Because they earn more profits
What is aggregate supply?
The quantity of real GDP which is supplied at difference price levels in the economy
Why does AS curve shift?
Cost of employment may change (wages, tax, labour, productivity) Costs of other inputs (raw materials, exchange rate, commodity prices) Government regulation (e.g. Environmental laws or taxes - RED TAPE)
What does SRAS curve show?
The period immediately after a change in price
Shows planned output of an economy when price changes
Whilst cost of production and productivity of the factor inputs are kept constant
What does the LRAS curve show?
The potential supply of an economy in the long run
When prices costs and productivity of factor inputs can change
When is macroeconomic equilibrium reached?
AD = AS
Evonomy reaches a state when rate of withdraws is equal to the rate of injections
Define the multiplier effect?
The theory that an initial injection of demand can lead to a greater change in the level of GDP
Quote about multiplier?
One persons spending is another persons income
What are the three ways to measure the economy?
Income
Expenditure
Output
What is net activity?
Injections minus leakages
What is an economic shock?
A sudden unexpected event hitting the economy disturbing either AS or AD
What is GDP?
The total value of goods and services produced n a country during one year
Define the accelerator theory?
A change in the level of investment in new capital goods is induced by a change in the rate of growth of national income or ad
Describe short run economic growth?
Growth in real output in the economy
Idle resources used
Slack taken up
Current FOP maximised
OutwRd shift of AD (low tax low interest)
Describe long run economic growth?
Expansion in the potential level of real output
Productive capacity of economy expands
FOP investment
AS curve shifts out
What is cost push inflation?
Inflation caused by changes in the costs of production
AS curve shifts in
Causes of cost push inflation?
Inavalibility of raw materials (war/ costs of supply)
Increase in minimum wage. (Costs of labour)
Increase in tax on a good
Poor weather - economic shock
Why does cost push inflation happen?
As firms costs rise more of the costs are passed on to the consumer by raising prices in order to cover the costs
What is demand pull inflation?
Excess demand usually when there is a positive output gap
Causes of excess demand?
Low tax - rise in C and I Low interest rates - rise in C and I Government spending rise Exchange rate (devalued) Excess confidence - C and I
Disadvantages of economic growth?
Inflation Environmental degradation Pollution (air and water) Urban sprawl Finite resources used Monopolies
Advantages of economic growth?
Increased standard of living Better healthcare More competition More tax paid Improved welfare Reduced unemployment More investment
What mainly causes the economic cycle?
AD fluctuations
Stagflation
high inflation and high unemployment and low demand
Supply side shock to the economy
eg sudden rise in costs of production
shifts SRAS onwards
lower growth in economy
cost push inflation
what does structural unemployment arise out of
immobility both occupationally and geographically
why does cyclical unemployment occur
as output falls
DUE TO THE FACT LABOUR IS DERIVED DEMAND
unemployment rises
