How the Macroeconomy Works, Circular Flow of Income, AD/AS Analysis and Related Concepts Flashcards
what does national income measure
the total value of the goods and services a country produces yearly
can be measured by GDP, GNP and GNI
what is the circular flow of income
a model of the economy that shows how money is distributed around it
shown here:
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what is aggregate demand
the total demand in an economy
what is the downward slope of the AD curve explained by
Higher prices lead to a fall in the value of real incomes, so goods and services
become less affordable in real terms
(when the GPL is high on the AD curve)
If there was high inflation in the UK so that the average price level was high,
foreign goods would seem relatively cheaper. Therefore, there would be
more imports, so the deficit on the current account might increase, and AD
would fall.
(when the GPL is high on the AD curve)
High inflation generally means the interest rates will be higher. This will
discourage spending, since saving becomes more attractive and borrowing
becomes expensive.
(when the GPL is high on the AD curve)
what equation determines shifts in the AD curve
AD = C + I + G + ( X - M)
an increase or decrease in any of these factors will shift the AD curve left or right
what does the SRAS curve show
shows the quantity of real GDP which is supplied at different price levels in an economy
the AS curve is upward sloping because at a higher price level, producers are willing to supply more because they can earn more profits
Only changes in the price level, which occur due to changes in AD, lead to
movements along the AS curve.
what are conditions that shift the SRAS curve
The cost of employment might change, e.g. wages, taxes, labour
productivity
The cost of other inputs e.g. raw materials, commodity prices, the
exchange rate if products are imported
Government regulation or intervention, such as environmental laws
and taxes, and business regulation. Business regulation is sometimes
called ‘red tape’.
There could be a net outward migration of workers, which causes a
‘brain drain’ on the domestic economy, as skilled workers move
elsewhere.
difference between the SRAS and the LRAS
The short run aggregate supply curve (SRAS) only covers the period
immediately after a change in the price level. It shows the planned output of
an economy when prices change, whilst the cost of production and
productivity of the factor inputs are kept constant
The curve is upward sloping because supply is assumed to be responsive to a
change in AD, which is reflected in the price level.
The long run aggregate supply curve (LRAS) shows the potential supply of an
economy in the long run. This is when prices, and the costs and productivity
of factor inputs, can change. Similarly to the PPF, it can show the economy’s
productive potential.
The curve is vertical, because supply is assumed not to change as the price
level changes.
A right-ward shift in the LRAS curve shows economic growth
what determines a macroeconomic equilibrium
The economy reaches a state of equilibrium when the rate of withdrawals = the rate
of injections. This is equivalent to the point where AD = AS
what makes up the consumer spending portion of AD
Disposable income - income left after taxes for consumers
marginal propensity to consume - how much a consumer is willing to spend after a change in their income
a consumers marginal propensity to save - the proportion of each additional pound of household income that is used for saving
what influences consumer spending
changes in interest rates - lower interest rates -> increased spending as little incentive to save
higher interest rates -> incentive to save
consumer confidence -> confident about the state of the economy so therefore spend more
If consumers fear unemployment or higher taxes, consumers may feel less
confident about the economy, so they are likely to spend less and save more.
what influences investment (a segment of AD)
the rate of economic growth -> firms making more revenue from higher consumer spending -> more money to reinvest
business confidence - if business expect a high rate of return -> they will invest more
demand for exports -> increased demand -> more likely that the firm will reinvest as higher sales are expected
interest rates
investment increases as interest rates fall -> means the cost of borrowing is less and the return to lending is higher
the higher the interest rates -> the greater the opportunity cost of not saving the money
moreover -> the higher interest rate -> might make firms expect a fall in consumer spending -> likely to discourage investment
The rate of corporation tax could affect investment. Lower taxes means firms
keep more profits, which could encourage investment.
what is the business cycle
refers to the stage of economic growth that the economy is in
the economy goes through periods of booms and busts
Boom, recession, slump, recovery, boom and repeat
what is an economic boom
when economic growth is fast, and it could be inflationary or
unsustainable.
what is an economic recession
negative growth for 2 consecutive quarters
During recessions, there real output in the economy falls, and there is negative
economic growth
During recessions, governments might increase spending to try and stimulate the
economy. This could involve spending on welfare payments to help people who have
lost their jobs, or cutting taxes
