Macro 6 - Short Run and Long Run Growth

Question 1

Short run and long run growth

Answer 1

> Short run growth means that, although the capacity of the economy remains the same, the total output of the economy has increased.
However, short-run growth can only take the economy so far before it’s at full capacity.
To increase any further, we must increase the quality and quantity of FoPs and so achieve long run growth.
Many of the factors that bring about long run growth will initially cause short-run growth as they require an increase in sending or investment.

Question 2

What does short-run growth depend on?

Answer 2

> Whether short-run growth alone can be sustained or whether it is always ultimately going to lead to inflation depends upon which model you use. Classical or Keynesian.

Question 3

Demand side shocks - definition

Answer 3

> Unexpected or sudden changes to AD that can have a significant impact on an economy.

Question 4

Supply side shocks - definition

Answer 4

> Unexpected or sudden changes to AS that can have a significant impact on an economy.

Question 5

Demand and supply side shocks - exam analysis

Answer 5

> In exam, analyse the shocks using AS, AD and SRAS, LRAS.
An economy might start to shrink or grow because it’s affected by a demand-side shock (which can cause AD to rise or fall) or by a supply-side shock (which can cause AS to rise or fall).

Question 6

Examples of demand-side shocks

Answer 6

1. Consumer confidence is boosted, e.g. by rising house prices, this will increase consumer spending.
2. If a country’s trading partners go into recession, this may significantly reduce demand for a country’s exports.

Question 7

Examples of supply-side shocks

Answer 7

1. Poor harvest reduces the supply of food, increases its price, and reduces the economy’s capacity.
2. The discovery of a major new source of a raw material will greatly reduce its price and increase its supply leading to increased capacity.

Question 8

Multiplier effect - definition

Answer 8

> The phenomenon whereby an injection into the circular flow of income ultimately leads to a greater increase in GDP.

Question 9

Multiplier - definiton

Answer 9

> A function, the value of which determines the extent of the difference of value of an injection and final increase in GDP in an economy.

Question 10

Average propensity to consume - definition

Answer 10

> The proportion of household income which is, on average, spent on consumption, rather than saved or otherwise withdrawn from the CF.

Question 11

Marginal propensity to consume - definition

Answer 11

> The proportion of any increase in household income which , on average, is spent on consumption.

Question 12

Marginal propensity to withdraw - definition

Answer 12

> The proportion of any increase in household income, which, on average, is withdrawn from the CF (i.e. saved, spent on imports or paid in tax).

Question 13

Multiplier explaination

Answer 13

> The multiplier effect works as one person’s expenditure becomes someone else’s income, so the money goes around multiple times until it’s all leaked out.
The money is utilised several times, each time increasing total income and output of goods and services.
Means that after a recession government injections are able to cause a significantly greater increase in GDP and employment.

Question 14

Average propensity to consume. Formula

Answer 14

> APC = consumption/ income.

Question 15

Average propensity to save. Formula

Answer 15

> APS = amount saved/ income.

Question 16

Marginal propensity to consume. Formula

Answer 16

> MPC = change in consume/ change in income.

Question 17

Marginal propensity to save. Formula

Answer 17

> MPS = change in saving/ change in income.

Question 18

Multiplier formula

Answer 18

> 1/ 1-MPC.

>1/ MPW.

Question 19

Which kind of people tend to have higher MPCs?

Answer 19

> People with lower incomes tend to have higher MPCs.

>MPC tends to be higher in less developed countries, so the multiplier will be bigger.

Question 20

Accelerator process - definition

Answer 20

> This is where any change in demand for goods/services beyond current capacity will lead to a greater % increase in the demand for the capital goods that firms need to produce those goods/services.

Question 21

Businesses and deciding to invest

Answer 21

> One way businesses determine whether investment is needed is to look at the current rate of change of national income.
So if national income is growing rapidly, then businesses will invest heavily.
This is called the accelerator effect.
Firms will make ‘accelerated’ investment in capital goods, expecting to increase output and make profit in the future.
This is likely to occur when the economy is going through a recovery, or at the start of a boom. These are times when demand will be rapidly increasing and firms will need to invest to meet this demand.

Question 22

Multiplier and accelerator

Answer 22

> The multiplier and accelerator work together:
-during a recovery, AD will be growing
-this leads to firms increasing their levels of investment which leads to another increase in AD
-this increase in AD is then multiplied, making the national growth more rapid…
-…which leads to more ‘accelerated’ investment.
Can also occur in reverse.

Question 23

Factors affecting the accelerator effect

Answer 23

> The greater the capacity:output ration, the greater the accelerator.
Higher interest = lower consumption = smaller accelerator effect.
If businesses import capital, the accelerator is smaller as leaks out of the CF.
Unsustained government spending leads to AE being lower as the firms know it won’t last.