Macro 1 and 2 REVISION Flashcards
Actual growth
The increase in actual (observed) output
Potential growth
The increase in the economy’s capacity
Business cycle
The periodic growth and decline of a nation’s economy
Demand-side policies
Increasing government spending
Lowering taxes
Monetary policy
Supply-side policies
Active labour market policies
Increasing technology
Encouraging investment
Benefits of economic growth
Increased consumption
Reduces other macroeconomic issues
Scope of redistribution
Costs of economic growth
Effects on distribution of income
Environmental costs
Depletion of resources
Workforce (labour force)
Those available and willing to work
Forms of unemployment
Frictional - inefficient job search - fluidity of labour market
Structural - Economic structure or regional effect
Seasonal - Interruption of economic activity depending on the season
Inflation
The continuous rise in prices of goods and services (measure the percentage change in price level)
Real flows
Trade in goods and services through the action of importing and exporting
Monetary flows
Transfers of capital that must exist to facilitate the real flows, plus other flows required to maintain exchanges in assets
Floating exchange rate regime
Exchange rate is determined freely by demand and supply in the foreign exchange (FOREX) market
Types of economic agents
Firms - average firm in the economy
Consumer - average consumer in the economy
Policymaker - a monetary authority
Types of markets
Labour market - between workers and firms
Goods market - between the consumer and the firm
Financial market - between the policymaker and both firms and consumers
Circular Flow Model
Two agents - Firms and households
Money flows from firms to workers (wage)
Money flows from households to firms (consumption)
Speed of flow can be influenced by:
1) Injections (investment (I), government spending (G), exports (X))
2) Withdrawals (Savings (S) , taxes (T) , imports (M) )
Equilibrium: Injections = Withdrawals
Equilibrium condition:
S+T+M = I+G+X
Keynesian Model
Argues the economy is demand led and firm’s production decision is based upon that demand
Aggregate production (Y) is determined by aggregate demand (E) - Y = E
In a closed economy the expenditure function (E) is written in terms of consumption (C), Investment (I) and Government spending (G):
Y = C + I + G
Aggregate Supply / Aggregate Demand Model
Demand curve represents average consumer - shows a negative relation between price and output (e.g. higher price means lower demand)
Supply curve represents average firm - predicts positive relation between price and production (e.g. higher price means more supply)
Money supply
Total amount of money in the economy
Role of Central Bank
Maintains nation’s currency and foreign exchange reserves
Responsible for monetary policy
Raises cash required for government borrowing’s and printing money when required
Types of monetary policy
Expansionary - actions that increase the money supply
Contractionary - actions that decrease the money supply
Tools of the Central Bank
Open market operations (buying or selling bonds)
Lending reserves to commercial banks
Changing required reserve ratio
Money market equilibrium
The supply and demand for money determine the money market equilibrium
Interest rate
The price of money - how much you have to pay extra of one currency to get a particular amount of a different currency
Expenditure
Consumption (C)
Investment (I)
Government Expenditure (G)
Y = C+I+G (represents market for goods and services)
Budget Surplus
Income exceeds expenditure
Budget Deficit
Expenditure exceeds income
Public Sector Borrowing Requirement (PSBR)
Amount of money the government requires to borrow in order to finance a budget deficit
Working age population
Number of citizens of working age
Natural rate of unemployment
The normal rate in the absence of shocks
Participation rate
Percentage of the working age population in the labour force
Labour market
Place where workers and firms interact to determine and equilibrium wage rate and amount of labour employed in the economy
Equilibrium unemployment
Unemployment that exists in all states of the economy
Disequilibrium unemployment
Unemployment ‘depending’ on the state of the labour market (e.g. due to demand deficiency)
Price
Nominal value at which a good is sold
Price of x = Market Fundamentals + Expected price of x in previous period
Aggregate price
Average price of a good in the economy
Trade off between price stability and economic activity
Inflation = Expected inflation + Market Fundamentals
To reduce inflation we can either try to make impact upon the MF or change our expectations of inflation
Market Fundamentals (MF)
The discounted present value of the stream of future cash flows attached to the asset - also described as the ‘items that have a direct impact on future income streams of a security’
Keynesian Cross approach to inflation
If equilibrium output is below full employment output then there is a deflationary gap
If equilibrium out is above employment output then there is an inflationary gap
Deflationary gap
Amount that national income exceeds aggregate expenditure (at full employment)
Inflationary gap
Amount that aggregate expenditure exceeds national income (at full employment)
Phillips curve
Maps out relationship between wage inflation and unemployment
Policymakers face a choice between inflation and unemployment:
1) To reduce inflation the central bank can increase interest rates - raises unemployment
2) To reduce unemployment the central bank can lower interest rate - raises inflation
Relationship appeared to be negative (downward sloping)
CONCEPT BROKE DOWN IN THE 1970s
Friedman’s Natural Rate Hypothesis (NRH)
Unemployment will deviate in the short run around its long run natural rate
Theory separates short run observations from the long run using the difference between inflation and ‘expected’ inflation:
When inflation is at its expected level, unemployment is at its ‘natural’ level
Deviations of unemployment from the natural rate are assumed short run
Reaction of unemployment to expansionary economic policy:
- Increase in aggregate demand decreases unemployment but creates unexpected inflation
- Increase in money supply causes movement along SRPC - unemployment declines and inflation is higher than expected - over time expectations adjust, SRPC shifts up and economy returns to natural state
