M12: Macro Environment

Question 1

What is the definition of economics?

Answer 1

“Economics is the study of how people and groups of people use their resources.”

Question 2

What are the 5 key macroeconomic objectives?

Answer 2

• Economic Growth
• Low unemployment
• Low inflation
• Avoidance of balance of payments deficits and exchange rate problems
• Income distribution

Question 3

What is the de-growth idea?

Answer 3

De-growth is a political and economic theory that advocates for a planned reduction in economic activity, consumption and production to address environmental and social issues.

e.g. climate change.

Question 4

What is the difference between fiscal and monetary policy and how do governments use these to achieve their objectives?

Answer 4

Fiscal policy relates to government spending and taxation whereas Monetary policy aims to control the economy by regulating the money supply,
credit availability, and interest rates.

Question 5

What is GDP?

Answer 5

GDP is the sum of the market values of all goods and services produced within an economy during a
specified period.

Question 6

What is circular income?

Answer 6

To model an economy, economists often use the “circular flow of income” model. This model simplifies
the economy into two sectors: households and firms.

These sectors interact by exchanging money and resources, which can be categorised into four
factors of production:
* Land
* Labour
* Capital
* Enterprise

Firms pay households for these factors, and households spend their income on goods and services produced by firms.

Question 7

What is aggregate demand (AD) and aggregate supply (AS)?

Answer 7

The totals of all the microeconomic demand and supply curves of individual companies.

Question 8

What happens at the equilibrium point between AD and AS?

Answer 8

Total output (Y) produced matches the amount of goods and services consumed.

Firms have no incentive to raise prices or increase output in this scenario.

Question 9

How do governments use fiscal policy and monetary policy to meet their macroeconomic objectives?

Answer 9

Government uses fiscal in either Expansionary or Contractionary way.

• Expansionary - increasing government spending or reducing taxation to boost AD,
• Contractionary - Cutting government spending or increasing taxes to lower AD.

Uses Monetary policy to simulate or dampen demand in a similar way to fiscal but by using money supply, interest rates etc.

• High interest rate = cutting demand as savings account pay more now and servicing existing loans will cut disposable income.
• Low interest rate = increasing demand as borrowing is cheaper and hardly any savings rate/needing to invest now instead.

Question 10

Do you know the formula for AD, and can you calculate it using the relevant information?

Answer 10

𝐴𝐷 = 𝑐𝑜𝑛𝑠𝑢𝑚𝑒𝑟 𝑠𝑝𝑒𝑛𝑑𝑖𝑛𝑔 (𝐶) + 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 (𝐼) + 𝑔𝑜𝑣𝑒𝑟𝑛𝑚𝑒𝑛𝑡 𝑠𝑝𝑒𝑛𝑑𝑖𝑛𝑔 (𝐺) + 𝑒𝑥𝑝𝑜𝑟𝑡𝑠 (𝑋) − 𝑖𝑚𝑝𝑜𝑟𝑡𝑠 (𝑀)

Question 11

What is the consumption function formula, and can you calculate it using the given relevant information?

Answer 11

𝐶 = 𝑎 + 𝑏𝑌

• C is the amount consumed for any level of income
• a is autonomous consumption, the amount that a person will consume if their income is zero
  (ie the amount of money needed to spend on basics to survive).
• b is the marginal propensity to consume (MPC). The MPC is the proportion of an increase in
  their income that a person will spend consuming goods and services. It must therefore be
  between 0 and 1.

Question 12

What is the multiplier effect, and can you calculate it using the given relevant information?

Answer 12

Multiplier effect whereby an injection into the economy leads to a greater increase in national income or GDP than the amount of the initial injection.

𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑛𝑎𝑡𝑖𝑜𝑛𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒 = 𝐼𝑛𝑗𝑒𝑐𝑡𝑖𝑜𝑛 𝑥 1 𝑀𝑃𝑆

1 / MPS is defined as ‘the multiplier’.

Question 13

What are the different types of unemployment?

Answer 13

Frictional - Unemployment that exists because of a person switching jobs, due to the time it takes to match prospective employees with jobs.

Seasonal - Unemployment at certain times of the year in industry sectors where the demand for labour is seasonal, for example, agriculture or tourism

Structural - Where the supply of labour in one industry outstrips the demand and people’s skills are too inflexible to be transferred easily to other industries. Structural unemployment can lead to variances in regional unemployment, depending on the types of industry located in a particular area.

Question 14

What are the two main economic theories used to explain the causes of unemployment in an economy?

Answer 14

1) Classical unemployment: This occurs when wage rates are artificially kept higher than equilibrium, often through government-set minimum wages or the
influence of trade unions.

2) Demand-deficient unemployment: In times of economic slowdowns or recession, aggregate demand falls, leading firms to reduce employment despite
inflexible wage rates.

Question 15

What are the possible policies governments can use to combat unemployment?

Answer 15

• Using interest rates (monetary policy) and/or tax rates (fiscal policy) to boost AD
• Geographical subsidies to encourage firms to invest in areas with high unemployment
• Changing the minimum or living wage rates

Question 16

What is inflation and what are the two measures of inflation called?

Answer 16

Inflation is the sustained increase in the price level in an economy. It erodes the purchasing power of money and can lead to economic uncertainties.

1) Demand-Pull Inflation: Occurs when factors increase demand, shifting the demand curve to
the right, causing both output and prices to rise.

2) Cost-Push Inflation: Arises when production costs, such as raw materials, increase, causing firms to supply fewer goods and services at higher prices.

Question 17

What are the different inflation measures?

Answer 17

• The Consumer Price Index (CPI)
• The Consumer Price Index with Housing costs (CPIH), which is derived from the CPI and is the ONS’ headline measure
• The Retail Prices Index (RPI), which is no longer designated as a ‘national statistic’ by the ONS.

Question 18

What problems can inflation cause beyond increasing the price level of goods and services?

Answer 18

1) Uncertainty - firms reluctant to invest, as financial managers will be unsure how future profits could be affected by cost increases. In addition, it would be difficult for firms to budget accurately since future selling prices and costs will be difficult to predict.

2) Redistribution of income - Savers will see a fall in the real value of their savings and will generally be worse off, while borrowers may benefit. Workers whose pay rises are capped will see a fall in real wages.

3) Balance of payments - country’s exports will become more expensive to overseas buyers. Export levels will therefore fall, leading to lower export revenue for the economy. Similarly, imports will seem cheaper to domestic consumers and will rise, causing a trade deficit.

Question 19

What is the circular economy?

Answer 19

The circular economy represents a fundamental shift in how we approach economic activity, emphasising sustainability, waste reduction, and resource efficiency.

Question 20

What are the three principles of the circular economy, and can you explain them?

Answer 20

1) Eliminate Waste and Pollution: Emphasises that products must be designed to re-enter the economy at the end of their use. This shift involves treating waste as a design flaw rather than an inevitable outcome. For instance, some companies are redesigning products like carpets to be 100% recyclable. Others are developing sustainable alternatives to plastic packaging, such as seaweed-based materials.

2) Circulate Products and Materials (at Their Highest Value): Keeping materials in use, either as
products or as components/raw materials, is central to this principle. It involves both technical and
biological cycles, encompassing reuse, repair, remanufacturing, recycling, and composting.

3) Regenerate Nature: The circular economy seeks to emulate natural systems where there is no
waste. It advocates for practices that help regenerate ecosystems, reduce pollution, and enhance
biodiversity. The food industry is a primary target for implementing regenerative practices.
Sustainable agriculture methods, including agroecology and agroforestry, aim to reduce
greenhouse gas emissions, enhance soil health, and increase biodiversity.

Question 21

What is the planetary boundaries concept?

Answer 21

The planetary boundaries framework defines nine critical boundaries within which humanity can thrive without causing irreversible environmental
changes.

Question 22

Can you explain the doughnut economics theory?

Answer 22

Doughnut economics, introduced by economist Kate Raworth, promotes an economic model that balances social foundations and planetary boundaries.

It challenges the pursuit of endless GDP growth in favour of equitable and sustainable development.

Question 23

What is sustainable development theory?

Answer 23

Sustainable development seeks to meet present needs without compromising the ability of future generations to meet their needs. It integrates economic, environmental, and social considerations to ensure development is responsible and equitable.

Question 24

Why do we want to move away from the linear economy and what can we move towards?

Answer 24

Because GDP isn’t the one thing that people care about and their are many other things:

• Happiness index
• Level of corruption
• Life expectancy
• Levels of literacy
• Unemployment levels
• Percentage of population earning at least a living wage

Move towards transitioning to a circular economy is seen as a way to address environmental challenges, reduce resource depletion and create a more sustainable and resilient economic system