macro Flashcards
the main macroeconomic objectives
the aims or goals of government policy
- economic growth (% change in GDP)
- price stability (control of cost and price inflation)
- high employment rate, low unemployment, reduced inactivity in the labour market
- sustainable overseas trade balance in goods/services/ balance of payments current account in equilibrium
- improved national well being/ higher standards of living
- net zero
- targets for reducing child poverty
- new house building
other macro economic objectives
- environmental protection (growth needs to be sustainable)
- improved productivity
- improved international competitiveness
- creating a good economic environment for investment
- improved public services (eg healthcare/education)
- sustainable government finances and balancing the budget
- more equitable final distribution of income and wealth (greater income equality)
- target for reducing poverty (esp child poverty)
objectives can change over time depending on context such as…
- in a cost of living crisis, achieving price stability may become more important than growth
- in a recession, achieving economic recovery can be highest priority
- climate change is pushing environment protection up on the list of priorities
gross domestic product (GDP)
measures the value of real output of the economy over a period of time; a rise in GDP indicates economic growth
real GDP
the nominal value of GDP adjusted for inflation (GDP at constant prices)
the annual % change in the consumer price index (CPI)
the ‘headline’ rate of inflation
what does the CPI track?
changes in the prices of a basket of goods and services purchased by an average household - expressed an an index number
retail price index (RPI)
the basket of goods/services includes some items not in the CPI, such as council tax and mortgage interest payments - often used to calculate increases in welfare benefits, pensions, index linked bonds and wage negotiations
in a period of rising interest rates it gives a higher rate of inflation than CPI
balance of payments
a record of all the flows of money between the residents of one country and the rest of the world
balance of payments on the current account
the section of the balance of payments that records international trade in goods, services , primary income and secondary income
balance of trade in goods and services
the value of exports of goods and services minus the value of imports and services - if this is positive, there is a trade surplus, if negative there’s a trade deficit
public finances
measured by looking at the budget deficit (gov borrowing when government spending exceeds tax revenue) and the National Debt as a % of GDP - The Budget and Autumn Statement reveal the government’s fiscal plans
public finances
measured by gini coefficient
comparing macroeconomic indicators across countries
- check you are comparing like for like
- think about what exchange rate is used or if data used purchasing power parity (PPP)
- to think about how the data was collected
- data accuracy (data collection may be more robust in some countries compared to others)
national income
the monetary value of the flow of output produced in an economy over a period of time
national income can be measured at any point as income flows around the economy so…
national income = national expenditure = national output
explaining the circular flow model
households earn income by selling their factors of production to firms and use it to purchase goods and services produced by the firms, which use up these resources
financial sector
not all income is spent, some is saved - the financial sector lends income saved to businesses to invest
government sector
some income is taken out of the flow as tax, but the government also spends which injects income into the flow
foreign sector
some income flows out to other countries when imports are purchased - exports add to the flow of income because income comes in from outside the economy
injections
add money to the circular flow of income which can lead to economic growth - they are investment I, gov consumption G, exports x
withdrawals
remove money from the circular flow of income which can lead to economic contraction - they are savings S, taxation T, imports M
national income equilibrium
planned injections = planned withdrawals
if injections exceed withdrawals, national income rises (economic growth)
if withdrawals exceed injections, national income falls (economic contraction)
aggregate demand curve (AD)
shows the relationship between the level of real planned expenditure and the general price level in an economy
AD formula
AD = C + I + G + (X - M)
consumption + investment + gov spending + (exports - imports)
factor that shifts AD curve - changes in monetary policy
lower interest rates make saving less attractive and borrowing cheaper, so consumers are more likely to spend; mortgage holders may also find their mortgage interest payment fall giving them more spending income; businesses are more likely to invest because borrowing costs are lower and saving any retained profit gives a lower return
factor that shifts AD curve - change in fiscal policy
the government can increase its own consumption and/or public investment (I) - it can fund this via more government borrowing - cutting income tax can boost, cutting indirect taxes such as VAT can also increase disposable incomes and cause consumer confidence to rise, cutting corporation tax may encourage more (I) - all these can cause AD to increase
factor that shifts AD curve - changes in the exchange rate and in the global economy
a depreciation reduces exports prices and increases import prices so net exports rise - global growth can also boost net exports (X-M)
reverse the chains of reasoning for all factors for decreasing AD
foreign direction investment (FDI)
capital investment made by a company based in one country in another country
why do firms invest?
- to expand their business and increase their output capacity
- to reduce average costs of production due to economies of scale
- to increase efficiency and productivity through innovation and technological progress
- to meet an increase in market demand and increase market share
- to expand a firm’s product range
- to replace depreciated capital
- to increase competitiveness at home and abroad
impact of investment on AD and AS
- investment adds to aggregate demand AD causing short run growth, lower unemployment
- successful investment also adds to the economy’s capacity, long run aggregate supply LRAS, long run non inflationary growth
factors influencing investment
- interest rate - lower interest rate reduces the cost of borrowing and boosts the attractiveness of investing relative to retaining profit; investment will increase
- availability of finance - if a firm is borrowing funds to invest, it has to access them from financial institutions, if they have funds, it will be easier to borrow
- demand for the final product - if the demand for a firm’s output increases, a firm has a greater incentive to expand to meet the demand, driven by potential for more profit
- business confidence - if business are confident about their future sales them they are more likely to invest
- corporate taxes - taxes on companies
- business regulation - a reduction in red tape and bureaucracy for businesses can incentivise more investment
- technological change - businesses will invest in new technologies/innovations to ensure they don’t lag behind competitors
how investment influences the macro economy
- creates extra demand in investment goods industries
- injects money into the circular flow of income (multiplier effect)
- boosts both short run and long run economic growth
- new capital boosts productivity and increases the capacity to supply
- improves a country’s competitiveness, improving the trade balance
- improves the economy’s infrastructure to make it more efficient
- can help create new jobs (eg lost to AI)
- can help reduce inflation pressure
role of gov spending
changing gov spending is a part of fiscal policy
- can be used to change the level of AD (with fiscal multiplier)
- can be used to provide public and merit goods
- can be used to correct market failures (eg positive consumption externalities)
- can be used to influence economic regions
- can be used to achieve greater equity in society by providing public services, including universal access to healthcare and education
decisions about how much the gov spends in the economy are often dependent on the gov economic and political goals
budget deficit
gov spending exceeds tax revenue - gov borrows to fund its spending
budget surplus
government spending is less than tax revenue - gov can pay back some of its debt
fiscal multiplier
estimates the final change in real national income (GDP) that results from an initial change in gov spending plans
trade surplus
net export demand is positive and adds to AD
trade deficit
net export demand is negative and reduces AD
trade balance equilibrium
value of exports is equal to value of imports - net export demand is neutral and AD doesn’t change
factors that shift the SRAS curve
- change in wage costs
- changes in productivity
- changes in unit labour costs
- change in commodity, energy and raw material costs
- changes in education/skills
- changes in indirect taxes and subsidies
- changes in the exchange rate
- changes in regulation
factors the shifts the LRAS curve
the LRAS represents the economy’s productive potential - its maximum output given its resources - LRAS is located at the economy’s full employment level of output
no spare capacity - shifts when theres
1. change in the quantity of resource (land, labour, capital and enterprise)
2. change in the quality of resources
3. technological progress
economic growth
increase in the potential output of an economy or in the real value of goods and services produced, measured by the % change in real GDP
human development index (HDI)
is calculated by the UN as an indicator of economic development and broader measure of the standard of living - it looks at
- health (life expectancy at birth)
- education (years of schooling and expected years)
- living standards (GNI per capita)
phases of economic cycle
- rapid expansion
- slowdown
- recession
- economic recovery
economic cycle
refers to the fluctuation of economic activity in an economy over time - involves alternating periods of expansion and contraction in real economic output, employment and other indicators
disadvantages of HDI
- still doesn’t take all aspects of wellbeing into account
- weighting of the three categories is arbitrary
advantages of HDI
- broader measure
- better measure of development
- better measure of standard of living and wellbeing
causes of an economic slowdown
- interest rate rise - banks may respond to an increase in inflation by raising interest rates to cool down the economy, reduce AD growth and prevent excessive inflation
- tighter fiscal policy - government may put up taxes or cut public spending to improve public finances, reducing AD growth
- a slowdown in global economic growth can negatively impact a country’s exports and economic prospects
causes of recession
- lower consumer confidence as disposable income decreases
- fall in business confidence - less investment = job loss
- higher unemployment - as businesses lay off workers, consumer confidence falls
- negative demand/supply side economic shocks
- poor choice of macroeconomic policy - keeps interests too high for too long
causes of an economic recovery
- cuts in interest rates (monetary policy) to stimulate AD
- fiscal stimulus (like tax cuts or increase in gov spending or borrowing)
- business and consumer confidence may increase boosting AD)
- positive demand/supply side shock
- more rapid global growth
rising unemployment
businesses reduce production and cut back on hiring, leading to job losses and rise in cyclical unemployment
disinflation
falling demand and a weaker labour market often leads to a reduction in the rate of price inflation
examples of economic shock
- pandemic (covid)
- brexit
benefits of economic growth
- higher standards of living
- greater profits for firms
- job creation
- reduced poverty
- greater income equality
- increased gov revenue
- investment opportunities
- improvement in environment
cost of economic growth
- inflation
- environmental costs
- income inequality
- financial instability
- wider trade deficit
- sacrificing current consumption
- human costs
unemployed
someone of working age, willing and able to work, actively seeking work but cannot find a job
unemployment rate
the percentage of the labour force that are unemployed
types of unemployment
- regional unemployment rate varies across regions
- mass unemployment
- youth unemployment
- discouraged workers
- hidden employment
- underemployment
technical unemployment
the displacement of human workers by machines, automation, and technology (AI)
frictional unemployment
short term unemployment caused by people moving between jobs, moving to a new location or reentering the workforce after a break
cyclical unemployment
the unemployment rate rises during an economic rate rises during an economic downturn - caused by fluctuations in the business cycle
structural unemployment
caused by changes in the economy, like the decline of certain industries or the rise of automation - happens when there’s a mismatch between the skills and location of workers and the needs of employers - lack of geographical and occupational mobility of labour contributes
real wage unemployment
caused by wages being too high relative to the productivity of workers - minimum wages and trade union activity can push the wage above its market equilibrium
costs of unemployment
- economic costs - fall in real incomes, lower standards of living, lower tax revenue, higher welfare costs, emigration
- social costs - increase in poverty and welfare dependency, increase in mental health increasing healthcare costs
benefits of some unemployment
- reduced risk of inflation
- pool of unemployed available for growing businesses
- increase in self employment start ups so more innovation
inflation
a sustained increase in the general price level
deflation
a sustained decrease in the general price level
costs of inflation
- uncertainty - consumers and businesses may reduce their spending causing unemployment and weaker growth
- loss of international competitiveness - weaker current account on the balance of payments as exports become relatively more expensive and imports relatively cheaper
benefits of low rate of inflation
- a low but steady rate implies AD is running ahead of AS, incentivising business investment and growth
- reduces the real value of debt
- allows negative interest rates
- helps labour markets work more efficiently without a need to cut nominal wages because real wages can fall
demand pull inflation
inflation caused by excess AD in the economy - producers can raise prices and increase their profits
causes of demand pull inflation
- lower interest rates
- lower income tax
- high consumer confidence
- positive wealth effects
- depreciation of the currency
causes of demand side deflation - fall in AD
inflation caused by a lack of AD in the economy - producers have to reduce prices and their profits fall
costs of deflation
- lower AD causes over supply
- lower prices for goods and services cuts cash flow and profits for businesses / consumers may delay their spending / businesses may cut investment
- businesses reduce production
- rise in real value debt
benefits of deflation
- falling prices for consumers
- increase in real incomes
- increased spending power for those on fixed incomes
- improved international competitiveness
- falling asset prices could make housing more affordable for firm time buyers
current account on the balance of payments
- trade in goods and services
- primary income
- secondary income
- current account balance
causes of a current account deficit
cyclical causes
- overvalues exchange rate
- boom in domestic demand
- recession in key export industries
- slump in global prices of exports
- increased demand for imported technology
- increase in global energy prices
structural causes
- under investment
- relatively low productivity
- persistently high relative inflation
- increase in global energy prices
stagflation
when both unemployment and inflation are high
demand side monetary policy
use of interest rates, changes in the money supply and/or changes in the exchange rates of affect the AD - run by Bank of England
how interest rates changes feed through to AD and influence inflation
- higher interest rates raise the cost of borrowing, which slows consumer spending and business investment
- reduces AD for goods and services and eases pressure on retail prices
- higher interest rates lead to an appreciation of the currency making imports cheaper which helps reduce inflation
expansionary monetary policy
cut interest rates, increase the money supply via QE to stimulate AD growth to prevent deflation - a depreciation on the currency can boost AD too
contractionary monetary policy
raises interest rates, decreases the money supply via QT to slow AD growth and help control inflation - an appreciation on the currency can slow AD too
exchange rate movements
- depreciation - happens inside a floating exchange rate system and means that one currency buys less of another so falls in value
- appreciation - happens within a floating exchange rate system and is an increase in the external value of one currency in relation to another so rises in value
when a currency depreciates or is devalues there is…
- an increase in import prices
- a decrease in export prices
this can lead to an increase in X and fall in M, increasing net X demand increasing AD
fiscal policy
use of taxation, gov spending and borrowing to influence the economy
demand side fiscal policy
fiscal policies that aim to manipulate AD to achieve the macroeconomic objectives
supply side fiscal policy
fiscal policies that aim to improve the supply side of the economy
types of taxation - fiscal policy
- direct tax (tax on income/wealth)
- indirect tax (tax on spending)
- progressive tax (tax that takes higher proportion of income from those on higher incomes)
- proportional tax (tax that takes the same proportion of income whatever the level of income
- regressive tax (tax that takes a lower proportion of income from those on higher incomes)
supply side policies
policies that focus on increasing the supply of goods and services in an economy to encourage greater productivity and faster economic growth
main aims of SSP
- improve incentives to work and invest in peoples skills
- increase labour and capital productivity
- increase occupational and geographical mobility of labour
- increase capital investment and research / development spending
- promote contestability and stimulate innovation (dynamic efficiency)
- improve price and non price competitiveness in global markets
globalisation
the deepening of relationships between countries, reflected in an increasing level of cross border trade and investment and migration
current account deficit
when the value of exports is less than the value of imports in goods and services, primary and secondary income - a net withdrawal from the circular flow
budget deficit
when the government spends more than it receives in tax revenue - a net injection into the circular flow
causes of a current account deficit
- cyclical causes of current account deficit - economy is booming, rising real incomes boost consumer spending increasing demand for imports, causing a wider trade deficit
- structural causes of current account deficit - from supply-side weaknesses like relatively low capital investment, low productivity / research and businesses not operating at the cutting edge of innovation
- short run causes - fall in value of exports, boom in consumer spending, appreciation of exchange rate
current account surplus
- trade surplus enables additions to foreign currency reserves and net exporting of capital
- net injection into economy
- positive export multiplier effects
- inflationary if there’s no spare capacity
- pressure on currency to appreciate
demand for a currency is…
an inflow of money into an economy - can be due to
- buying exports of goods and services
- overseas portfolio inflows into property, shares and bonds
- hot money flowing into a country’s banking system
supply of a currency is…
an outflow of money into an economy - could be due to
- domestic spending on imported goods and services
- outflow of portfolio flows in property, shares and bonds
- hot money flowing out of a country’s banking system
- outflows of FDI
free floating exchange rate
- currency value is set purely by demand and supply of the currency
- currency can either rise or fall
- no intervention by central bank
- no target for ER
managed floating exchange rate
- central bank gives freedom for market exchange rates on a day to day basis, supply and demand factors drive the currency’s value
- central bank may intervene occasionally
- currency becomes a key target of domestic monetary policy
floating exchange rate systems adv/disadv
adv
- independent monetary policy
- shock adsorption
- reduced speculative attacks
- currency reserves
disadv
- exchange rate volatility
- currency risk
- inflation pass through
- loss of exchange rate as a policy tool
characteristics of less developed countries
- low per captia income
- high levels of poverty and inequality
- limited infrastructure for transportation, communication and electricity networks
- dependences on primary commodities
role of aid and trade
aid - provides immediate relief and support to countries facing economic challenges, helping to address urgent needs such as healthcare, education and infrastructure development but can lead to more debt
trade - facilitates long term sustainable growth by fostering the exchange of goods and services, encouraging specialisation, and promoting investments, thereby stimulating economic development and improving living standards over time
laffer curve
the relationship between tax rates and gov revenue - at very high tax rates, people are disincentivised to wrok/save/invest there may be more tax avoidance/evasion/possible drain so cut in tax rate could generate economic growth and increase tax rev
