Macro 6: Short Run and Long Run Growth

Question 1

What does short run analysis mean in macroeconomics?

Answer 1

The quantity and quality of factors of production are fixed so the capacity of the economy remains the same.

Question 2

What does short-run growth mean?

Answer 2

Although the capacity of the economy remains the same, the total output of the economy has increased. This can be because of a shift in SRAS or AD. But this can only take an economy so far before it’s at full capacity as it’s then impossible to produce any more of one good or service without producing less of something else.

Question 3

How do we achieve long-run growth?

Answer 3

By increasing the quantity or quality of factors of production to increase output any further once full capacity has been reached. This can be achieved through a number of methods like increased government spending or infrastructure, increased private investment in capital, increased labour productivity (through improvements in capital) and immigration of skilled workers into the economy.
Many of the actions that will bring about LR growth will initially cause SR growth as they require an increase in spending on investment.

Question 4

What are demand-side and supply-side shocks?

Answer 4

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

Question 5

How would shocks affect SRAS or LRAS?

Answer 5

SRAS- an event that suddenly increases or reduces costs of production
LRAS- an event that suddenly increases or decreases the quantity or quality of factors of production

Question 6

Will the shock affect AD, SRAS or LRAS?
1. A recession in the EU leads to a rapid fall in income.
2. Trading on the foreign exchange market leads to a sharp fall in the value of the pound.
3. The global price of oil increases sharply.
4. Foot and mouth disease causes the deaths of millions of cattle.
5. Discovery of the Loch Ness monster draws millions of tourists into Scotland.
6. The UK discovers rich seams of precious metals under the North Sea floor.
7. A contagious disease incapacitates 1/5 of the population.
8. A hurricane destroys infrastructure such as bridges and phone lines.

Answer 6

1. AD shifts inwards
2. SRAS shifts inwards, AD shifts outwards (exports look cheaper)
3. SRAS shifts inwards
4. SRAS and LRAS shift inwards
5. SRAS and AD shift outwards
6. LRAS and AD shifts outwards
7. AD and SRAS shift inwards
8. LRAS shifts inwards

Question 7

What is the multiplier effect?

Answer 7

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

Question 8

Why does the multiplier effect happen?

Answer 8

Because the money that is initially injected is utilised multiple times, each time increasing total income and total output of goods and services.

Question 9

What does the multiplier effect mean in a recession?

Answer 9

During or after a recession, the government can inject a sum of money into the economy and cause a significantly greater increase in GDP and employment.

Question 10

How can you benefit the most from the multiplier?

Answer 10

By encouraging consumers to save less and spend more of their income.

Question 11

What is the multiplier?

Answer 11

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

Question 12

What is average propensity to consume?

Answer 12

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

Question 13

What is marginal propensity to consume (MPC)?

Answer 13

The proportion of any increase in household income which, on average, is spent on consumption, rather than saved or otherwise withdrawn from the circular flow.

Question 14

What is marginal propensity to withdraw (MPW)?

Answer 14

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

Question 15

What is the equation for mpw?

Answer 15

mpw = mps (savings) + mpt (tax) + mpm (imports)

Question 16

What happens if mpm, mpt or mps increase?

Answer 16

mpw will increase and mpc will decrease.

Question 17

What is the formula for mpc?

Answer 17

mpc= change in consumption / change in income

Question 18

How can the multiplier (K) be calculated?

Answer 18

K = 1/1-mpc = 1/mpw = 1/mps+mpt+mpm

Question 19

Which 4 components add up to 1 and why?

Answer 19

mpc + mps + mpt + mpm = 1
because there’s nothing else you can do with your income other than spend it, save it, or pay tax with it

Question 20

What happens if the value of withdrawals is small?

Answer 20

The smaller the value of withdrawals (and the larger the value of the mpc) the larger the value of the multiplier.

Question 21

What is the change to national income following a £6bn injection assuming mpc is 0.7?

Answer 21

1/1-0.7 x 6bn = £19.9bn

Question 22

A company builds a new production unit in a certain country. Explain how this investment is likely to have a ‘multiplier’ effect?

Answer 22

Investment is an injection so household income rises so a higher proportion is spent than saved which becomes income to businesses (creates new goods) and that becomes new household income and so on.

Question 23

Why does the multiplier vary between countries?

Answer 23

There are different levels of withdrawals. Poorer countries spend more money on consumption rather than saving.

Question 24

Why do developed countries have a lower multiplier value?

Answer 24

They have already met their basic needs so have higher saving rates and a higher mpw.
mpc is higher for developing countries.

Question 25

Which factors affect mpc?

Answer 25

Interest rates- if they’re high, save more
Tax rates- if high, low mpc
Inflation- if high, value of savings fall so high mpc
Income level- rich save more so low mpc
Currency strength- strong pound means more imports so low mpc

Question 26

What will a reduction in interest rates do to the size of the multiplier and why?

Answer 26

Increase as savings fall so more consumption.

Question 27

If there’s a recession what happens to people’s job security and why?

Answer 27

Falls because firms don’t have enough money to provide good wages, cyclical unemployment rises.

Question 28

What will a recession do to the value of mpc and mps?

Answer 28

mpc rises because the value of money falls so consumers want to get rid of it
mps falls savings hold less value

Question 29

If people whose income is increased by the injection are on low income (eg. job seekers) how will mpc be different from a situation where the wealthiest members of society have an increase in income?

Answer 29

mpc is higher for low income members because wealthy members don’t have necessities to buy so will put their money into savings or investment rather than spend it.

Question 30

If there’s high inflation are people more likely to save or spend additional income?

Answer 30

Spend now as the money is losing its value.

Question 31

What happens to the multiplier if interest rates are increased?

Answer 31

There are more savings so mpw goes up so the multiplier value falls.

Question 32

What happens to the multiplier if tarrifs (tax) on imports are increased and what information from micro helps us work out the effect of this tariff?

Answer 32

Falls as more savings so higher mpw.
PED

Question 33

What is the accelerator effect?

Answer 33

When an increase in national income causes a proportionally greater increase in investment spending.

Question 34

Why does the accelerator effect happen?

Answer 34

If demand rises, firms need to increase investment spending to increase their supply capacity to meet demand, driven by the profit motive.

Question 35

What will the impact of the accelerator be on AD?

Answer 35

Increases because injections and economic growth mean mpc rises as there’s more income in households so more willing and able to buy goods.
Further increase AD - the increase in I is in itself a new injection increasing AD further and so will also cause its own multiplier effect further increasing AD

Question 36

What will the impact of the accelerator be on LRAS?

Answer 36

Increases because of an increase in capacity.

Question 37

Give 2 examples of how the accelerator may apply in specific industries?

Answer 37

Mobile networks and airlines

Question 38

What is the negative accelerator?

Answer 38

Growth of demand slows then investment spending falls.

Question 39

What is capital:output ratio?

Answer 39

The ratio of an increase in capital spending needed to gain a given increase in output.
Eg. If £50m is needed to increase output by £10m capital output is 5:1 like in car-manufacturing

Question 40

How is capital:output ratio linked to the accelerator?

Answer 40

If capital:output ratio is high then more investment is needed so it increases the accelerator effect.

Question 41

If interest rates are increased, what happens to the size of the accelerator?

Answer 41

Falls because greater incentive to save and more expensive to take loans for investment.

Question 42

If firms import most of their capital, what happens to the accelerator?

Answer 42

GDP falls because X-M falls so AD falls so less demand means less investment.

Question 43

If the gov are increasing national income through increased spending and provision of welfare payments but firms don’t believe this will be sustained, what happens to accelerator?

Answer 43

Falls as low consumer confidence so AD falls.

Question 44

If industries most affected by the increase in national income can increase capacity without significantly increasing capital stocks, how will this impact the accelerator?

Answer 44

Falls because don’t need a lot of investment.