Intro to Macroeconomics Flashcards
What is Circular flow of income?
The Circular flow of income is a theoretical model for understanding the workings of an economy. It illustrates the flow of money as well as goods and services between the 4 sectors - Households, Firms, Government, and Foreign sectors, in an economy. It shows how these different economic agents are inter-related and how a country arrives at a certain level of national output, national expenditure, and national income.
What are the two involved principles in the circular flow of income?
i) In every economic transaction or exchange, the seller receives exactly the same amount that buyer spends
ii) For every real (Goods and services) flow in one direction, there is a corresponding money (payment) flow in the other direction
What does the 4-sector economy consist of?
i) Households
ii) Firms
iii) Government
iv) Foreign sector
What are Withdrawals (W)?
Withdrawals refer to any part of household income that is not spent on goods and services produced by the domestic firms. The effect of any withdrawals is to cause the flow of income to contract or diminish
W=S+T+M
What are Injections (J)?
Injections (J) refer to expenditure on domestic output that do not arise from domestic households. The effect of any injections is to cause the flow of income to expand
J=I+G+X
What are the three methods of measuring circular flow of income?
i) Expenditure method
ii) Output method
iii) Income method
What is the Expenditure method?
The Expenditure method measures the total amount of spending by consumers, firms, government and foreigners on the final output produced within the economy in a specified time period, usually a year
What is the Output method?
The Output method measures the total value of final output of goods and services produced within the economy in a specified time period, usually a year
What is the Income method?
The Income method measures the total income earned from all factors of production producing the final output within the economy in a specified time period, usually a year
What is the definition of Aggregate Demand (AD)?
The Aggregate Demand (AD) curve gives the total demand for a country’s output at various general price levels, ceteris paribus
What is Consumption Expenditure (C)?
Consumption is spending by households on consumer goods and services.
This spending covers non-durable goods (e.g. food), durable goods (e.g. cameras and cars) and services (e.g. entertainment, transport)
What are the determinants of Consumption (C)?
i) Size of Disposable Income of the Households (Affected by Direct Tax and Transfer Payment)
ii) Households Net Wealth
iii) Income Distribution
iv) Interest Rates and Availability of Credit
v) Consumers’ Confidence - Expectations about Employment, Prices and Income
vi) Invention of New Consumer Goods and the Influence of Advertising
vii) Tastes and attitude towards saving
How do you determine Household Disposable Income (Yd) ? (equation)
Household disposable income = Personal Income + (Transfer payments - Personal income taxes)
What is Investment Expenditure?
Investment is the acquisition of new fixed capital goods (including housing, plant and machinery) and accumulation of inventory stock (raw materials, semi-finished goods and finished goods held by the producer).
What are investment decisions generally based on?
i) The expected rate of return on the investment (MEI);
ii) The cost of the investment (Interest rate); and
iii) Profits and other costs of production incurred by the firm
What is the Marginal Efficiency of Investment (MEI) ?
The Marginal Efficiency of Investment (MEI) is the expected rate of return of investment or the Internal Rate of Return (IRR) of the investment in a capital good.
What is Interest Rate?
Interest Rate is the cost of borrowing funds to make the investment i.e. the cost of the investment
What is the MEI theory?
According to the MEI theory, a firm will only invest if the expected rate of returns on investment (MEI) is greater than the current rate of interest
Note: A fall in interest rate is not likely to attract more foreign direct investments
(FDIs) into the country as foreign investors are likely to come with their own
source of money to invest and not borrow funds in the country they intend to
invest in.
.
What are the determinants of Investment?
i) MEI vs Interest Rate
ii) Expectations of Businesses
iii) Technological Progress
iv) Prices of Inputs & Availability of Inputs
v) Government policies
What is Government Expenditure (G)?
Government Expenditure constitutes government spending on final goods and services. These include spending on public goods like defence for the nation, for economic growth (eg. spending on education), for social needs of the population (e.g. building of community centres and home for the aged)
What are the determinants of Government Expenditure?
The level of government expenditure is often determined by political, social, and economic reasons.
What is Aggregate Supply (AS)?
The Aggregate Supply (AS) refers to the total value of domestic goods and services produced within the economy at every general price level.
What are the determinants of Long Run Aggregate Supply (LRAS) ?
i) Changes in the quantity of FOP
ii) Changes in the quality of FOP
iii) Changes in Technology
What are the determinants of Short Run Aggregate Supply (SRAS) ?
i) Changes in Cost of Production
eg. Rise in FOP will result in decreased SRAS, shifting the SRAS curve upwards due to higher COP
What is the Multiplier Process?
The multiplier/national income multiplier shows the number of times by which national income changes when there is an autonomous change in AD
What is Autonomous Expenditure?
Autonomous Expenditure refers to expenditure that DOES NOT depend on income
What is Induced Expenditure?
Induced expenditure refers to expenditure that varies with income
What is the formula of multiplier(K)?
k=1/mpw OR k=1/1-mpc of domestic output
What is the formula of the multiplier process?
Change in Y=(k)(change in AD) OR Change in Y=(K)( change in J)
What is the determinants of the size of the multiplier?
The larger the size of multiplier, the larger the final increase in national income
The value/size of the multiplier is inversely related to the size of the withdrawals/leakages from the economy. The higher the marginal propensity to withdraw, the smaller the size of multiplier
What is the formula for the Marginal Propensity to Withdraw (MPW)?
MPW= MPS+MPT+MPM
Note: The increase in general price level will have a dampening effect on the multiplier as the higher prices would cause purchasing power of households to fall, dampening the increase in induced consumption due to the higher income
What is Gross Domestic Product (GDP)?
Gross Domestic Product (GDP) refers to the value of all final goods and services produced by factors of production located within the geographical boundaries of a country, within a period of time.
