macro Flashcards
What is Aggregate Demand and its formula?
Total demand for a country’s goods and services at a given price level and time period.
Formula: AD = C+I+G+(X-M)
What is consumption?
Spending of household on consumer products. Largest component of AD
What are the 6 determinants of Consumption?
- Wealth effect
- House prices
- Interest rates
- Confidence / Animal spirits
- Direct and Indirect tax rate
What is investment?
Spending on capital goods. It is the most volatile in AD
What are the determinants of investment?
- Interest rates
- Confidence
- Tax rates
- Risk
- Market demand
- Technological change
- Market competition
What are the determinants of net exports?
- The exchange rate
- The relative level of inflation
- Global confidence and demand
What is Government expenditure?
Spending of central and local government on goods and services.
What is jobseeker’s allowance?
Benefits paid from the government to the unemployed looking for a job.
What is trade surplus and deficit?
Surplus: when exports exceed imports
Deficit: when imports exceed exports
What is real GDP?
The countries output measured in constant prices and so adjusted for inflation.
What is GDP?
The total output produced by a country.
What is interest rate?
The charge for borrowing money and the amount paid for lending money or reward for saving money
What are the 4 macro objectives?
Sustainable economic growth: measured by GDP
Unemployment: full employment is 3%
Inflation: measured by consumer price index (CPI) and retail price index (RPI) - target rate is 2%
Balance of payments: measured in terms of value of net exports.
What is national income?
measures the total value of all goods + services produced in an economy
What are the 3 methods of calculating national income?
Income method, Output method, Expenditure method
What is the circular flow of income?
Economic model showing the flow of goods and services, the FOPS’s and their payments between households and firms within an economy
What are the positive and negative output gaps?
Positive: occurs when an economy temporarily grows faster than the trend rate, operating in the short run beyond its full capacity
Negative: occurs when AD is growing at a slower rate or falling in relation to its productive potential
What are the different types of unemployment?
Structural: caused by a mismatch of skills between the unemployed and available jobs
Frictional: period of time when workers are moving between jobs
Cyclical: a lack of employment as a result of fluctuations in the economic cycle/economy
Seasonal: occurs through fluctuations in demand throughout the year/seasons
Regional: a town or region experience a downturn, e.g. big companies moving away
Technological: increased degree of automation in production process, so replacing jobs
How does unemployment affect individuals?
- Lower living standards
- “Deskilling”
- Health implications such as stress etc
- Social issues: divorce, crime, social dislocation
- Unemployment trap (benefits)
- Long term employability
How does unemployment affect the economy?
- Lost output
- Increased government spending (positive) decreased tax so economy grows
- Lower international competitiveness
- Rising inequality
- Loss of resources invested in training
- Lower consumer spending
What are the 3 types of productivity?
Labour: output per worker
total output/no. Of workers
Capital: output per unit of capital, e.g. machines
Factor: average output of all FOP’s
The current account
Primarily records the trade in goods
What does the balance of payment include?
- The current account
- The financial account
What is the multiplier effect?
When an initial injection into the economy, or circular flow of income causes a larger final increase in the level of the real nation income/output
Formula:
final change in real GDP/initial change in AD
What is the negative multiplier effect?
Occurs when initial withdraw of spending from the circular flow leads to knock-off effects and a final drop in real GDP
What is MPC?
Marginal propensity to consume (MPC) measures how much more individuals will spend for every additional dollar of income. MPC is calculated as the ratio of marginal consumption to marginal income.
What is MPC?
Marginal propensity to consume (MPC) measures how much more individuals will spend for every additional pound of income. MPC is calculated as the ratio of marginal consumption to marginal income.
What are the reasons for disparity between regions?
- Low skilled economy
- Poorer education
- Low wages
- Greater reliance on benefits
- More 0 hour contracts
- More business deaths than birth ; high unemployment ; negative multiplier effect
- Lack of businesses in area
What is the positive wealth effect?
If a wealth of a household increases, consumption will increase
Why will rising house prices lead to increased consumer spending?
- House owners have greater equity available (difference between the market value of the property and the outstanding mortgage loan)
- When house prices rise, people feel wealthier and this positive wealth effect leads to more consumer spending
- More people tend to move when property values are rising and spend more on household durables such as furniture
Why does higher interest rates lead to less consumer spending/expenditure?
- Increases incentive to save
- Cost of borrowing is higher, and will be harder to pay back, so it reduces incentive to borrow
- Higher mortgage interest payments, leaving households with less disposable income and lower confidence
What is direct and indirect tax?
Direct: tax levied on the income or profits of the person who pays it
Indirect: a tax levied on goods and services
What does investment spending refer to?
Spending by firms o capital goods, such as buildings and equipment, to produce more consumer goods
What is gross investment?
Total amount the economy spends on new capital, including capital depreciation
Net investment
Formula:
gross investment - depreciation
Physical wealth
Made up of items such as houses, cars and furniture, also known as assets
Monetary wealth
Comprised of items such as cash, money in a bank account, stocks and shares, and pension rights
If there is a cut in direct taxation, then…
Ceteris paribus, consumers will experience an increase in their disposable income and spending power
An increase in indirect taxes such as import duties or VAT will cause…
Prices to rise and consumer’s purchasing power to fall
The large income tax cuts in taxes in the Lawson budget of 1987
The large tax cuts will have led to an increase in consumption expenditure as households disposable incomes rose.
This in turn will have led to an increase in aggregate expenditure and therefore output.
AD shifts to the right
The fall in consumer and business confidence following the 2008 financial crash
The fall in consumer and business confidence will have lead to consumers reducing their MPC.
Firms pause investment projects and resume when confidence resumes.
Lower consumer and investment spending will reduce AD
AD shifts to the left
What is investment?
Spending on capital goods such as machines, factories, new technologies, etc…
How does increased interest rate affect investment?
The cost of funding investment is higher, lowering the expected rate of return on a capital project
How does high risk and uncertainty affect investment?
Business investment may fall
How does (corporation) taxation affect investment?
Corporation tax is paid depending on the level of business profits.
If the government reduces the rate of corporation tax, there is a greater incentive to invest.
(The main rate of corporation tax in the UK has been reduced from 28% in 2010 to 21% in 2015, it is currently at 19% and due to fall to 18% in April 2020)
How does market demand affect investment?
Consumer spending increase + stronger investment
Higher expected sales also increase potential profits
In other words, the price mechanism should allocate extra funds and factor inputs towards capital goods into those markets where consumer demand is rising.
How does competition impact investment?
Companies may have to invest just to remain competetive
How does confidence impact investment?
During a down-turn, many businesses may postpone investment because they feel demand will not be high enough to give them the rate of profit they need.
What are the 5 macroeconomic roles of investment?
- Contributes to AD, creating economic growth
- Enlarges production base (quantity); increasing production capacity
- modernises productions processes (quality): improving cost-effectiveness and productivity
- Allows for the production of new and improved product which can improve our standard of living
- Improves international competitiveness
What is the accelerator affect?
Firms increase level of investment to meet demands
White elephant
A possession considered expensive without use or value
Why might over-investment be problematic?
- Cost overruns and causes huge debt loads
- Negative externalities such as pollution and environmental damage
- creates an illusion of growth but not sustainable growth
- If there is insufficient consumer demand, the infrastructure will not be used (White elephant)
- High level of imports could worsen trade deficit
- Wasteful ; opportunity cost
What is a public and merit good?
Public - impossible to exclude anyone, and one person’s consumption doesn’t reduce availability for others
Merit - Goods and services which would be under-consumed if not provided by the government, e.g. healthcare and education
What does the government spend the most on and receive the most from?
Spend - welfare, healthcare, education
Receive - income tax, VAT, National income
What is a budget deficit?
When the government spends more than it receives in tax revenue
What is austerity?
Economic policy aimed at reducing a government deficit and can be achieved through increases in government revenues
What are the factors affecting exports and imports?
- Exchange rate: price at which one currency is sold for another
- Relative level of inflation: the higher the level of relative inflation in the UK, the lower the demand for UK export
- World and UK income: when the world economy is booming, foreign income is rising fast, providing UK exporters with an opportunity to sell more exports
What is Balance of payments (BOP)
Record all flow of money in and out of a country
What are the 4 section of the current account?
- Trade in goods
- Trade in services
- Investment and employment income “primary income”
- Transfers “secondary income”
What is aggregate supply (AS)?
The total value of output of the economy at a given price level at a given point in time
What are the main determinants of AS?
- Production cost
- Price level
What leads to an expansion + contraction?
Expansion: rise in price level
Contraction: decrease in price level
What is assumed about short - run?
All FOPs’s are fixed
What causes short - run aggregate supply (SRAS) to shift?
- Wages: if wage rate increases, the firms may substitute labour for capital
- Price of raw materials: the higher they are, the higher the firm’s costs of production and will reduce SRAS
- Productivity of land labour and capital can change in short - run
- Tax and subsidies: Increase in business tax rates will increase costs of production and SRAS decreases
An increase in business subsidies will lower costs of production - Exchange rates and imports: many businesses import raw materials or components for production process, if the currency strengthens this makes purchasing them relatively cheaper and SRAS increases.
What are the determinants of long - run aggregate supply?
- Technology
- Productivity
- Attitudes
- Enterprise
- Factor mobility
- Economic incentives
Why is the classical LRAS curve vertical?
Classical economists believe that the LRAS curve is a vertical line at the full employment level of resources. This is because they think that in the long run the economy will operate at the full employment level of resources
What shifts the LRAS curve(s)?
- Land: if additional land for production becomes available or new primary raw materials, the productive potential of the economy will improve therefore LRAS increases
- Labour: Increase in the size and quality of labour force, such as training + education, output will increase
- Capital: Increase in quantity +quality + productivity of capital will boost LRAS due to improvements in tech + research + development
- Government incentives: often use frameworks to improve level of competition in markets
- Entrepreneurship: improved incentives to set up new businesses, or invest in the development of new goods and services, boosts LRAS
What does the Keynesian LRAS curve represent?
As perfectly elastic at low output, then upward sloping over a range of output, and finally perfectly inelastic at the full employment level of output. This is to emphasise their point that, in the long run, an economy can operate at any output level and not necessarily at the full employment level.
What types of capacity is there from the beginning of the K-LRAS curve to the end?
- Unused capacity: firms can increase output without increasing costs
- Limited spare capacity: as economy nears full employment, firms find it difficult to attract scarce resources so prices rise
- Full capacity: there is full employment and all resources are used
When does macroeconomic equilibrium occur?
When AS = AD
How does increases in consumption affect the K-LRAS?
AD will shift to the right, so there is an expansion along the LRAS curve and price level will increase as economy gets to full employment, and resources become more scarce
How does increases in consumption affect the K-LRAS?
AD will shift to the right, so there is an expansion along the LRAS curve and price level will increase as economy gets to full employment, and resources become more scarce
How does increases in capital efficiency affect K-LRAS and AD?
There is an expansion along the AD curve as LRAS shifts outwards and price level decreases ; available factor resources are increases and scarcity reduces
Real national output increases + maximum productive potential increases, indicating economic growth
Economic growth in short-run and long - run
Short - run: The actual annual % change in RNO
Long - run: An increase in the potential productive capacity of the economy
What is a boom characterised by?
(The economic cycle)
- Increased economic growth
- Increased demand
- Decreased unemployment
- Inflationary pressure
- Labour skills shortages
- Increased confidence in economy
- Increased capital investment
What is a recession characterised by?
(The economic cycle)
- Fall in demand
- Increased unemployment
- Decreased investment so Decreased confidence
What is a slump characterised by?
(The economic cycle)
- Increased bankruptcy
- -ve growth
What is a recovery characterised by?
(The economic cycle)
- Economic growth begins to rise
- increasing demand
- Unemployment begins to decrease
- inflation increases
- Confidence in economy increases
What is ‘Level + Rate unemployment’?
Level: Number of people who are unemployed
Rate: as a %
formula:
unemployed/labour force x 100
(labour force excluded those willing and able to work/economically active people)
What is frictional unemployment?
(short term)
In-between jobs unemployment – e.g. new entrants into the labour market such as school & college leavers
- Geographical immobility of labour
Problems with moving into new countries or regions can cause frictional unemployment - Occupational immobility of labour
Problems with training for jobs that require new skills
What is structural unemployment?
Occurs because of worker’s lack of skills needed for certain jobs, or the location of these jobs are not available to move closer to them in order to work
It is not that jobs are not available, but more that there is a serious mismatch between what companies want and workers can offer
What is cyclical unemployment?
Results directly from cycles of economic upturn and downturn. Unemployment tends to rise during recessions and declines during economic expansions
An example of this when the Great Recession following the financial crisis of 2008 led to construction workers being laid off
This can impact businesses negatively as they experience a drop in their profits
What is seasonal unemployment?
Without jobs due to the time of year when there are seasonal changes in employment:
For example, fruit-pickers in the summer are
occasionally put out of work in the winter
Many workers adapt to this by working quite a bit and saving up as much as they can from their earning
What are the 2 ways to measure employment?
- Claimant count: the number of people claiming jobseekers allowance
- Labour force survey (LFS): Quarterly survey of approximately 60,000 households compiled by the Office of National Statistics studying the employment circumstances of the UK population
What are some of the problems with the claimant count?
- Not everybody whose looking for a job gets the jobseekers’ allowance (JSA) ; self-employed workers who are temporarily unemployed tend not to claim
- Under 28s and 60s do not count
- Changing criteria for JSA
- Some people who are claiming JSA aren’t actively looking for jobs
- Some have jobs i the shadow economy but still claim benefits
1 - 3 : underestimates unemployment statistics
4 - 5 : overestimated unemployment statistics
Is the labour fore survey better?
- More internationally recognised
- Potential for analysis of data - you can pick up on trends
- Picks up trends un sectors
- A better guide for policymakers - (government, fiscal, monetary, supply side policy)
- Generally accepted to be more accurate
HOWEVER → it is costly to compile and subject to sampling and extrapolation errors
What are the 2 factors the consequences of unemployment depend upon?
- The rate of unemployment
- The duration of unemployment
There will be consequences for…
- The economy
- Businesses
- The unemployed
What are the consequences of unemployment on the economy?
- Lost output: there is significant wastage of economic resources, and it is likely that the economy will be producing within the PPF. If there was full employment, then the economy could produce closer to the PPF e.g. Point Y (on the curve)
- Increased government spending on employment programmes.
- Lost tax revenue through lower income tax receipts. There is also likely to be lower consumption, so VAT receipts will also fall.
What are the consequences of unemployment on the business/firms?
- Decreased demand for goods and services → consumption decreases due to decrease in disposable income
- Decreased profitability
- Decreased incentive to invest
- Decreased morale and productivity of remaining workforce, who are perhaps concerned over future potential job losses
- Decreased productivity
What are the consequences of unemployment on individuals?
- Lower living standards: the unemployed have decreased income, so reduced standard of living
- Social cost: unemployment can enhance the likelihood of illnesses such as depression and cause mental stress as strains are placed on family finances
- Financial costs: looking for work incurs a time cost + more time spent at home may increase utility bills
- KEY STRUCTURAL FEATURE: Deskilling (hysteresis): the longer you are unemployed, the more deskilled you become as workplace skills are not developed
- Reduced chances of finding work; the longer you are unemployed, the less likely you are to find a job
NEETS
Not in Education, Employment or Training
How do changes in the rest of the world affect employment and unemployment in the UK?
Globalisation has impacted on employment and unemployment in the UK:
- Competition from low-cost economies has led to a significant decline in UK manufacturing
→ This has fallen from 22% to 11% in the last
decade as traditional industries such as
textiles have been undercut by foreign
imports - However, emerging markets such as the BRICS and MINT economies have allowed new market development and exports of high quality UK goods and services has created employment in the UK
What is voluntary unemployment, and what may be the reasons for it?
When workers choose not to work at the current equilibrium wage rate
- Excessively generous welfare benefits
- High rates of income tax
- Workers seeking better employment conditions
It is likely to occur when equilibrium wage rate is below necessary wage to encourage individuals to supply their labour
What is involuntary unemployment?
People are unable to work because there are insufficient jobs available in an economy and prepared to accept existing wage rate but unable to find a job
What is Real wage unemployment?
Occurs when wages are above equilibrium level, causing the supply of labour to be greater than demand
What are the factors that determine real wage employment?
- Trade unions: through collective bargaining, a trade union may be able to negotiate higher wages for its members and if successful in doing so, number of workers prepared to offer their labour increases but demand for that labour decreases which creates involuntary unemployment
- National minimum wage (NMW): if it’s introduced or increased from its existing level, this may cause real wage unemployment as workers supply their labour more readily and the wider the gap between the equilibrium wage rate and the NMW, the greater the extent of the real wage unemployment
What is natural rate of unemployment?
The natural rate of unemployment is defined as the equilibrium rate of unemployment
It is assumed that full employment, i.e. 100% of the labour force has a job, is not possible because there will always be a certain level of frictional unemployment in existence
There is also likely to be some degree of structural unemployment, where employers are unable to fill vacancies due to the skill set of the unemployed and so therefore said that there will always be a degree of voluntary unemployment in an economy
What are factors that determine the natural wage rate of unemployment?
- Skills and education: if quality, availability of education/training schemes improves, then the natural rate should fall down as structural unemployment issues are tackled
- Availability of job information: With enhanced information, frictional unemployment should fall and reduce natural rate
- Occupational mobility; Any labour immobility, geographical or occupational, will increase natural age rate
- Labour market flexibility: The greater it is, the lower the natural rate, for example weaker trade unions or looser employment legislation
- Hysteresis: If unemployment rises during a recession, workers may be deskilled and their human capital will diminish as they become long term unemployed. As a result, they are less able to get new jobs when the economy recovers and become structurally unemployed, thus increasing the natural rate
(LRAS curve) What sides are each type of unemployment on?
(supply side and demand side)
Structural, frictional and seasonal unemployment are all supply-side causes of unemployment
Cyclical unemployment is primary factor of demand side
Therefore, any supply - side causes of unemployment will affect the position of the long - run aggregate supply curve
