Macro 1-4 Flashcards
What 7 things should successful economic policy result in?
(macroeconomic objective)
- Economic growth
- Stable prices
- Low unemployment
- Balanced balance of payments (imports and exports record)
- Equality in distribution of income and wealth
- Balanced budget
- Protection of the environment
Circular flow of income model
Households give labour and expenditure
Firms give wages and goods/services
Injections into the circular flow of income model
X - Exports
I - Investment
G - Government spending
Leakages from the circular flow of income model
M - Imports
S - Savings
T - Taxes
Injections definition
Money flowing into the circular flow of income
Leakages definition
Money flowing out of the circular flow of income
Aggregate demand definition
total demand of goods and services in an economy
What is aggregate demand made up of?
- Consumption (65%)
- Investment (15%)
- Government spending (G)
- Net exports (X-m)
What are 6 determinants of consumption?
- RDI
- Wealth
- Consumer confidence
- Interest rates
- Age structure
- Inflation
How does RDI Increase consumption?
Why might RDI not increase consumption?
RDI increase = Consumption increase = AG increase
- some income is saved.
- Low income people will spend more than High income people.
How does wealth affect consumption?
Why might wealth not affect consumption?
Wealth effect -> Assets price increase, people feel richer and spend more, consumption increases.
UK is nation of homeowners so wealth effect is significant.
- people might save income.
- Most people are unlikely to make spending decisions based on a one off increase in house price.
Why will consumer confidence affect consumption?
Why will confidence not affect consumption?
Confidence increases -> Consumption increases -> AD increases.
- Some people won’t feel confident.
- Fall in salary, people will be less inclined to spend.
- if interest rates go up, people may choose to save.
How will Interest Rates effect consumption?
Why will interest rates not affect consumption?
Save more -> Borrow less -> spending decrease -> Consumption decrease, AD decrease.
- Commercial banks may not pass on rate changes.
- Rich households not affected.
How does Age structure of population affect consumption?
Why might age structure not affect consumption?
Young - spend for education and luxuries.
Middle - Save for kids, spend for family and house.
Old - Likely to spend.
- Middle aged may not save for retirement.
- old people may save for children.
Why might inflation affect consumption?
Why might inflation not affect consumption?
People cut back on luxuries but spend same on needs. Consumption decreases.
- hyperinflation - people spend very quickly
Marginal propensity to Consume (MPC)
The change in consumption from a change in income
What happens when MPC increases?
An increase in consumption in response to an increase in income
MPC Formula
Change in consumption / Change in income.
why is mpc expected to be between 0 and 1?
because people will not spend all of the increased income, they will save some of it.
Marginal propensity to save (MPS)
The change in savings from a change in income
What happens when saving increases?
Consumption decreases
What 6 things determine volume of saving
- RDI
- Interest rates
- Confidence and expectations
- Government policy’s
- Age structure of population
- Access to banks
How does RDI affect volume of saving?
Higher RDI -> more saving -> Consumption decreases
Why might RDI not affect volume of saving?
-People may spend income.
-May not apply to wealthy households.
How does interest rates affect volume of saving?
Increase = save more
lower = borrow more, save less
Why won’t interest rates affect volume of savings?
Not all households affected such as the rich.
How does Confidence and expectations affect volume of savings?
Higher confidence -> less savings
Less confidence -> more saving
Why might confidence and expectations not affect volume of savings?
Rich not affected .
If interest rates increase, people might save anyway.
How does government policy’s affect volume of savings?
Government may provide incentives to save so:
-you have money when ur old or to reduce inflation.
Why might government policy’s not affect volume of savings?
Some people choose not to save, they choose leisure over savings.
How does access to banks influence volume of savings?
If people don’t have access to a bank, they are less likely to save.
Why might access to banks not affect volume of saving?
If people don’t have access to banks, they may hold cash in safes.
How does age structure influence volume of saving?
- Middle age people save the most.
- young people save less because they have less.
- old people save less.
why might age structure not affect volume of saving?
- Old people may save for their children.
- Young people may save for their future.
What is investment?
Investment is the addition to the capital stock of the economy (spending on capital goods)
Why is investment so volatile?
Totally based on confidence
What are the 7 things that determine investment?
- Economic growth
- Animal spirits
- Profit levels
- Corporation tax / tax on profits
- Interest rates
- Capacity utilisation
- Demand for exports
How does economic growth affect investments?
Economic growth -> Investment
Economic growth implies consumption, and firms need to supply the demand
Why won’t economic growth affect investments?
Businesses may choose to pay dividends to shareholders instead of investing
How does animal spirits / confidence affect investment?
High animal spirits -> Investment
confident consumers will keep spending
Why won’t animal spirits affect investment?
Confidence is volatile
Why does profit levels affect investment?
Profit increase -> Investment increase
Why might profit not affect investment?
May choose not to invest
How does corporation tax (tax on profits) affect investment?
25% in UK
Corporate tax increase -> Investment falls
profits decrease, investment falls
Why might corporation tax not affect investment?
Businesses could make investment decisions independent of tax rates (Keynes suggested animal spirits was more influential)
How does interest rates affect investment?
Decreases investment
Why might interest rates not affect investment?
Rich may continue to invest
What is capacity utilisation?
How much percentage of a factory’s production is currently being utilised
How does capacity utilisation affect investment?
If factory is at full capacity, it should invest in capital goods
Why might capacity utilisation not affect investment?
Instead, it could be high animal spirits which cause investment into capital goods
Why might demand for exports not cause investment?
some business may already be able to handle more demand and dont need to invest.
What is animal spirits?
Gut feeling (irrational decision)
What is depreciation?
a reduction in the value of an asset over time
What is net investment calculation?
Gross investment (Initial value) - Depreciation = net investment (present value)
What is government spending?
Spending by central and local government on things like healthcare, infrastructure, military, law enforcement and education.
What is transfer payments?
A transfer payment is a payment of money for which there are no goods or services exchanged (central to local government)
What 3 things determine government spending?
- Level of economic activity
- Economic objectives
- political situation
How does level of economic activity determine government spending
Less economic activity > more gov spending
Why might level of economic activity not determine government spending?
Corruption
Tax not collected in every country
How does economic objectives cause gov spending?
Reduce inflation > cut spending
They will spend more money if not meeting economic objectives
Why might economic objectives not influence gov spending?
Gov spends money even if they are meeting their economic objectives
Why does political situation affect gov spending?
War > spend more on military
What 3 factors influence how much a country spends on healthcare?
- access to finance
- Health crisis
- Ageing population
What 6 factors influence Net Exports?
- RDI at home
- RDI Abroad
- Price level
- Exchange rates
- Trade barriers
- Non-price factors
How does RDI at home affect Net exports?
RDI increase > Consumption increases > Some in form of M (imports)
How long has the uk been in trade deficit?
over 30 years
Why might RDI at home not affect net exports?
It depends on the increase in income
WHy does RDI abroad affect net exports?
RDI abroad increases > Exports increase
Who is uk main trading partner
european union
Why might RDI abroad not affect net exports?
UK not known for producing mass market
Why does price level (domestic inflation) affect net exports?
High inflation leads to uk goods having less demand
Exports decrease, Imports increase
How does exchange rates affect net exports?
SPICED - Strong pound makes imports cheaper and exports dearer
WIDEC - Weak pound makes imports dearer and exports cheaper
Why does trade barriers affect net exports?
Tariffs - tax on imports
Quotas - limit on imports
Decrease in exports and imports.
Why might trade barriers not affect net exports?
Depends on size of tariffs
Why does non-price factors affect net exports?
Good quality goods - More exports.
Bad quality goods - less exports
Why might non-price factors not affect net exports
price also heavily determines demand
How does an decrease in price level affect AD?
Extension of aggregate demand
What 3 effects explain why the AD curve is downwards sloping?
- Wealth effect
- Trade effect
- Interest rate affect
What is the wealth effect?
as average price falls, individuals can purchase more of a good or service with the same money. Therefore consumption will increase
What is the trade affect?
Price falls, exports become more competitive, and sell more exports
What is the interest rate affect?
Interest rates are low encouraging investment and consumption.
what causes a shift of the AD curve?
any of the determinants of the components of AD.
How does an increase in interest rates affect AD?
(strands)
A significant increase in interest rates means that the reward for saving increases. This will lead to a fall in spending, decreasing consumption. Consumption is the biggest component of AD with 65%. AD is likely to fall. This is a problem for the UK as its a nation of homeowners. People with variable rate mortgages will see their mortgages increase. Firms are likely to invest less in capital goods. The AD curve shifts to the left. There will be a decrease in the rate of real GDP from Y1 to Y2.
