macro Flashcards
macro
A government’s budget
is an annual statement of projected outlays and
receipts during the next year
Government’s budget balance
Budget balance = Receipts – Outlays
budget surplus: receipts > outlays
budget deficit: receipts < outlays
balanced budget: receipts = outlays
Four sources of receipts
- Taxes on income and wealth
- Taxes on expenditure
- National Insurance contributions
- Other receipts and royalties
Three categories of outlays
- Expenditures on goods and
services - Transfer payments
- Debt interest
𝐺𝑜𝑣𝑒𝑟𝑛𝑚𝑒𝑛𝑡 𝑑𝑒𝑏𝑡 =
𝐺𝑜𝑣𝑒𝑟𝑛𝑚𝑒𝑛𝑡 𝑑𝑒𝑏𝑡 = 𝑝𝑎𝑠𝑡 𝑑𝑒𝑓𝑖𝑐𝑖𝑡𝑠 − 𝑝𝑎𝑠𝑡 𝑠𝑢𝑟𝑝𝑙𝑢𝑠𝑒𝑠
+ 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠 𝑡𝑜 𝑏𝑢𝑦 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝑟𝑒𝑐𝑒𝑖𝑝𝑡𝑠 𝑓𝑟𝑜𝑚 𝑡ℎ𝑒 𝑠𝑎𝑙𝑒 𝑜𝑓 𝑎𝑠𝑠𝑒𝑡𝑠
The effects of the income tax
- The income tax decreases the supply of labour and create a new labour market equilibrium - The before-tax wage rate rises, the after-tax wage rate falls and employment decreases
The Laffer curve
- The relationship between the tax rate and the amount of tax revenue collected - a higher tax rate rises pre-tax wage rate but reduce labour hours so it does not always bring in more revenue
Autononmous spending
- Autonomous expenditure is the sum of investment, government
expenditure, and exports, which does not vary with GDP
Aggregate expenditure
𝐴𝐸 = 𝐶 + 𝐼 + 𝐺 + 𝑁𝑋
• where AE is aggregate expenditure, C is consumption, I is investment, G is
government spending, NX is net exports.
Fiscal stimulus
is the use of fiscal policy to increase
production and employment.
ways to stimulate economy fiscally
an increase in government outlays or a decrease in government receipts can stimulate production and jobs - an increase in expenditure on goods and services directly increases aggregate expenditure - lower tax also strengthen the incentives to work and invest
Monetary policy objectives
The Bank of England Act of 1998 sets out the objectives of UK monetary
policy:
To maintain price stability
subject to that, to support economic growth and employment.
The act also establish the Monetary Policy Committee
is the committee of nine members in the Bank that has the responsibility for
setting monetary policy.
monetary policy: Price stability objective
The operational definition of price stability since the beginning of 2004
has been:
An inflation target of 2 per cent a year as measured by the 12-month increase in
the CPI.
target range is from 1 per cent to 3 per cent.
Government economic policy objectives
• The government’s economic policy objectives are to achieve high and
stable levels of economic growth and employment.
Price stability is a major contributor to achieving the other goals of
government economic policy.
price stability provides the best available environment for households and
firms to make the saving and investment decisions that bring economic growth
Rationale for an inflation target
First, the Bank of England’s policy actions are more clearly understood by
financial sector.
A clear understanding leads to fewer surprises and mistakes on the market
rates
i.e., rises interest rate when inflation is high
Second, the target provides an anchor for expectations about future
inflation.
firmly held (and correct) inflation expectation help individuals and firms to
make better economic decisions, which in turn help to achieve a stable
economic growth.
The monetary policy instrument
The Bank of England choose quantity of reserve supplied Bank Rate (i.e., price) - The Bank’s choice is Bank Rate, which is the target for the repo rate (the overnight interest rate at which banks borrow reserves from central bank) - The market for bank reserves. • banks’ demand for reserves is a derived demand • repo rate is closely related to market interest rates • the lower the repo rate, the higher the demand for money, thus the higher banks’ demand for reserve
The Bank of England can use open
market operation
to control the quantity of reserve supplied in the market, and thus move the repo rate to its target level, i.e., Bank Rate. • to decrease reserves in the market the Bank conducts an open market sales (sell bonds and buy reserves) • to increase reserves in the market the Bank conducts an open market purchases (buy bonds and sell reserves)
Money policy transmission: bank lowers bank rate
- bank of england lowers bank repo rate
- other short term interest rates fall and the exchange rate
- the quantity of money and supply of loanable funds increase
- long term interest rate falls
- consumption expenditure, investment and met exports increase
- aggregate demand increases
- real gdp growth and the inflation rate increae
Money policy transmission: bank raises bank rate
- bank of england raises bank rate
- other short term interest rates rise and the exchange rate rises
- quantity of money and supply of loanable funds decrease
- long term interest rates rise
- consumption expenditure, investment and net exports decrease
- aggregate demand decreases
- real gdp growth and the inflation rate decreases.
Real GDP
is the value of final goods and
services produced in a given year
at the prices of a reference year
Potential GDP
is the quantity of real GDP at full employment – when the economy’s labour, capital, land and entrepreneurial ability are fully used. • data is not collectable
Economic growth
is the growth rate of potential GDP that measures the pace of movement
of production possibilities
Real GDP per person
the standard of living depends on real GDP per capita
-𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 𝑝𝑒𝑟 𝑐𝑎𝑝𝑖𝑡𝑎 =
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜n�
- if ∆ 𝑟𝑒𝑎𝑙 𝐺𝐷𝑃 > ∆ 𝑝𝑜𝑝𝑢𝑙𝑎𝑖𝑜𝑛 ⇒ 𝑟𝑒𝑎𝑙 𝐺𝐷𝑃 𝑝𝑒𝑟 𝑐𝑎𝑝𝑖𝑡𝑎 ↑
if ∆ 𝑟𝑒𝑎𝑙 𝐺𝐷𝑃 < ∆ 𝑝𝑜𝑝𝑢𝑙𝑎𝑖𝑜𝑛 ⇒ 𝑟𝑒𝑎𝑙 𝐺𝐷𝑃 𝑝𝑒𝑟 𝑐𝑎𝑝𝑖𝑡𝑎 ↓
What determines potential GDP?
Potential GDP is when an economy is produced at its full capacity, when
the economy’s labour, capital, land and entrepreneurial ability are fully
use.
A two-sector model
Assume fixed quantity of capital, land, entrepreneurs, and productivity.
- To determine potential GDP we use a model with two sectors:
An aggregate production function
An aggregate labour market
Aggregate production function
shows how real GDP changes as the quantity of labour changes when all other factors remain the same. An increase in labour increases real GDP but by successively smaller amount
Aggregate Labour Market
The real wage rate is the nominal wage rate divided by the price level • Labour market equilibrium if there is a shortage of labour, the real wage rate rises to eliminate it if there is a surplus of labour, the real wage rate falls to eliminate it when there is neither a shortage nor a surplus, the labour market is in equilibrium, i.e., a full-employment equilibrium.
Labour productivity
is the quantity of real GDP
produced by an hour of labour.
equals real GDP divided by
aggregate labour hours.
what happens when labour become more productive
- If labour become more productive, firms are willing to pay more for a given number of hours so the demand for labour increases. - the real wage rate rises and the equilibrium quantity of labour increases
Why Labour Productivity Grows
The growth of labour productivity depends on:
• Technological advances
the discovery and the application of new technologies
and new goods
• Physical capital growth
such as machines, buildings, or factories
The accumulation of new capital increased capital per
worker and increased labour productivity
• Human capital growth
such as skills and experience
Human capital acquired through education, on-the-job
training, and learning-by-doing
The financial markets
provide the channels through which saving flows to
investment in new capital
Physical capital and financial capital
Physical capital
is the tools, instruments, machines, buildings and
other items that are used to produce goods and
services
an increase in the quantity of capital increases
production possibilities and shifts the aggregate
production function upward
financial capital
the funds that firms use to buy physical capital
Three main financial markets:
Loan markets
– loan lent on condition that it is repaid on agreed dates and an
agreed rate of interest
– usually are non-tradable
Bond markets
– bond is a promise to make specified payments on specified dates.
– bonds are usually issued by firms and government.
Stock markets
– a stock is a certificate of ownership and claim to the firm’s profits
– such as the London Stock Exchange, the New York Stock Exchange.
The Loanable Funds Market
The market for loanable funds
• assumes a single financial market, which is the
aggregate of all the individual financial markets.
• in reality, the financial market is much more
complicated, as there is a large variety of financial
products.
The nominal interest rate
is the number of pounds that a borrower pays and a
lender receives in interest in a year expressed as a
percentage of the number of pounds borrowed and
lent.
The real interest rate
is the opportunity cost of borrowing (the alternative is consumption)
• is the nominal interest rate adjusted by inflation
• is approximately equal to the nominal interest rate minus the inflation
rate
the market for loanable funds, supply and demand
The market for loanable funds • determines the real interest rate,
the quantity of funds loaned,
saving and investment.
• first ignoring the government
The demand for loanable Funds • The real interest rate the higher the real interest rate,
the smaller is the quantity of
loanable funds demanded
The supply of loanable funds • The real interest rate the higher the real interest rate,
the greater is the quantity of
loanable funds supplied
An increase in the demand for
loanable funds
expected profit the greater the expected profit, the greater is the amount of investment and the greater the demand for loanable funds. • corporate tax rate a lower corporate tax increases net profit and encourages investment, thus increases demand for loanable funds.
An increase in the supply of
loanable funds.
disposable income A household’s disposable income is income minus net taxes when disposable income increases, both consumption expenditure and saving increases. • expected future income the lower a household’s expected future income, the larger is its saving today • default risk default risk is the risk that a loan will not be repaid. the lower that risk, the larger is the supply of loanable funds
aggregate supply
is the relationship between the quantity of real gdp supplied and the price level
aggregate demand
is the relationship between the quantity of real gdp demanded and the price level.
price index formula
(cost of basket at current period / cost of basket at base period prices) *100
inflation rate formula
(price index at t - price index at s)/price index at s
*100
GDP deflator formula
(nominal gdp/real gdp) *100
Income approach
Gross domestic income at factor cost
- compensation of employees
- gross operating surplus
- Mixed incomes
Expenditure Approach
Gross domestic product at market price
- consumption expenditure
- investment
- govt expenditure
- rotf
employment rate formula
(employed/working age pop.)*100
economic activity
(economic active/working age pop.)x100
natural employmennt is frictional and structural
natural unemployment/economically active
working age pop
16-64 years
economically active
includes employed and unemployed
economically inactive
- in full time education or retired
unemployment rate
( unemployed/aconomic active) x 100
nominal gdp
is the value of goods and services produced durign a given year valued at the market price.
What is the laffer curve?
Laffer to show the relationship between tax rates and the amount of tax revenue collected by governments.
The curve is used to illustrate Laffer’s main premise that the more an activity — such as production — is taxed, the less of it is generated. Likewise, the less an activity is taxed, the more of it is generated.
