Macro economics Flashcards
Circular flow of income Economy
These injections and leakages in the circular flow are tracked and compiled as national income data. When governments publish national income data, these statistics are more commonly referred to as gross domestic product (GDP) . GDP tries to measure the value of everything produced in a country in a specific time period.
GDP
This refers to the total monetary value of all final goods and services produced by factors owned by the country’s citizens in a given period of time
adv:
Allows comparison across countries
Informs policy makers
Gives an indication of average income
disc
- Overestimates the quality of life:
Does not account for disparity in income distribution
Contains inaccuracies
Does not account for improvements in quality of output:
GNI
This refers to the total income of a nation’s people and businesses.
Approaches to measure national income
- output method
outpurts of firm in given period
many limitations on what is included
but gives idea of economic sectors - income method
adding up all the income of factors of production being sold in resource markets - expenditure method
total sales recppiets for goods and services sold in the economy
Nominal GDP vs real GDP
GDP refers to the market value of all final goods and services produced within the borders of a country within a given period of time. Read GDP takes into account inflation.
This refers to the GDP calculated in a given year without consideration for inflation.
GDP per capita vs GNI per capita
This refers to the GDP divided by the population of a country, giving an average income per citizen.
Real GNI per capita is another statistic used in national income accounting which actually indicates the income per person in the country. It is calculated by the formula:
GDP, GDP per c and GNI formulas
Real GDP growth = nominal GDP growth adjusted for inflation
GDP per capita = (Total GDP/Population)
GNI = GDP + Net property income from abroad
Purchasing power parity
PPP compares economic productivity and standards of living between countries on the basis of relative costs of goods and services.
To find real GNI..
To find real GNI, you must take the GDP, subtract the incomes of foreign citizens, living domestically, then add the incomes of citizens living abroad, and finally divide that number by the
deflator
The business cycle
an expansionary phase
a peak phase
a contractionary phase
a trough
The business cycle
an expansionary phase
a peak phase
a contractionary phase
a trough
Alternative measures of well being instead of GDP
Gross National Happiness
adv: happines in economic development citizises economy by citizens
Better life Index
- housing, jobs, community, health
narrow indicators influenced by personal preferences of participant
Happy planet Index
wel being, life expecting, ecological FP,
Gross national happiness
factors of progress just as important of economic aspects
Green GDP
-the more rubbish higher GDP a
- amount of money spent t mitigate CH
Agregate demand
AD is the total value of goods and services demanded by different groups at a given price level in an economy. It is the sum of the expenditure categories that make up GDP at a specific price level.
Aggregate demand = C + I + G + (X − M)
AD Curve
As shown in Figure 1, as the average price level in the economy falls from P1 to P2, there is an increase in the number of goods and services demanded in the economy from Y1 to Y2
Determinants of aggregate demand
AD shifts due to these components
consumption
investment
government spending
exports
the aggregate demand curve will shift rightward (outward) or leftward (inward) depending on whether the change in the component causes an increase or a decrease of AD
Consumption in AD
- Confidence
low confidence reduce AD
2Unemployment
Threat reduced AD
Wealth
AD grows if people feel wealthy
Personal taxes
am of tax affects ad
future price expectatoions
Investment in AD
- interest rates
high – ad left - business confidence
- Technology
boosts market ad rigt
taxes
left
Government in AD
pend vast quantities of money in their economies, such as on hospitals, roads, public sector employees, and so on.
more get spending more AD
Net exports
Trade enables countries to benefit from each other’s strengths in production in the global economy
- income of trading partners
incomes rise, shift hight - exchange rates
value of currencies that determine P - Trade policies
taxes, restrictions,
Aggregate supply
AS refers to the total output that all firms in a country are able to produce at any given price level.
Aggregate supply in the short run
SRAS is the supply of the nation in the short run, or when resource prices for most firms will remain constant.
s firms receive higher prices for the goods that they sell, they will be more willing and able to produce output, as long as their costs of production, especially wages, remain constant in the short run.
SR determinants
- resource prices
like energy changes or labor cost
- got intervention
business taxes, regulation - subsidies
help reduce costs - supply shocks
when overall aggregate supply is affected by an event
New classical view AS
monetarist believes on market power
. If resource prices are allowed to rise and fall according to market behaviour, then all resources can be fully employed in the long run, maximising the nation’s output.
The economy will always return to the full employment level of output (or potential GDP) as the price level has no effect on the full potential of output.
perfectly inelastic long-run aggregate supply (LRAS) curve.
The new classical school assumes that if prices are fully flexible in the long run, the price level does not affect the level of output of firms and their profits, so firms have no incentive to produce more in the long run. If the price level of goods and services falls, and firms can lower wages of workers, then firms can employ the same number of workers and produce the same output.
Kensyan school view on AS
he Keynesian AS curve is divided into three sections:
The horizontal section, where there is a good deal of spare capacity in the economy
The upward sloping section, where there is some spare capacity but we are beginning to see some competition for scarce resources
The vertical section, where full employment is reached
Unless wages fall, firms have no choice but to make workers redundant during a recession. This is because they sell fewer goods, as aggregate demand is low, and so look for ways to keep profits from falling. This explains the gap between Y1 and Yfe and the resulting unemployment in the labour force. Firms find it very difficult to reduce people’s wages, although it is not impossible to do so
It is only when the economy nears Yfe and resources have to be allocated between competing uses that prices start to rise.
Aggregate supply and factors of production
While the SRAS curve shifts due to factors that change the costs of production, the LRAS represents the potential capacity of an economy’s factors of production. In other words, the quantity and quality of a country’s land, labour and capital.
Whether using the new classical or Keynesian view, the LRAS curve will shift rightward (outward) if any of the factors increase in quality or quantity. In turn, this increases the potential of the economy.
Macro Equilibrium in the short run
An inflatioary gap is when
AD invtraes and the real GDP is more than the potential GDP
It is due to price level increaing , and economy operating at more than its full employment
SRAS shifting leftwards causing stagflation
SRAS also can affect the short-run macroeconomic equilibrium in the economy. As seen in Figure 2c, SRAS1 can shift leftwards if there is a supply shock or increase in the resource prices. Then the economy will produce less real GDP but the price level will increase. This economic situation is known as stagflation and is especially undesirable in the economy as there is a falling GDP, rising unemployment and a rising price level.
Shiifts in aggregate demand
n increase in aggregate demand from AD1 to AD2 will result in an increase in real output from Y1 to Y2. The average price level will need to increase too, from P1 to P2, to allow firms to cover the increased production costs associated with increased volumes of output.
Shifts in AD and AS
Equilibirum in the long run (new clasicl)
mprovement in confidence, and aggregate demand increases from AD1 to AD2
upward pressure on the price level from P1 to P2.
In the long run, short-run aggregate supply will shift from SRAS1 to SRAS2 and return to the full employment level.
Equilibirum in kenys long run
As resources become more fully employed, it is only by raising prices that resources can be redistributed from one use to another.
Keynes believed that economies could get stuck at Y1 unless otherwise assisted by government spending.
Demand pull inflation
Demand-pull inflation occurs when there is an increase in aggregate demand in the economy. In order to supply the increased number of goods and services now required, higher prices are needed. I
Cost push inflation
Cost-push inflation occurs when aggregate supply falls. This will always be caused by an increase in the costs of production or a sharp disruption in the availability of the factors of production. T
Costs of inflation
Uncertainity difficukt for businesses to plan
More harmful to low income households
Value of savings decrease
Damage to exports competitivness
economic resession
Monetary policy
central bank actively manages money in the economy
MONEY SUPPLY INTEREST RATES
Goals of monetary policy - influencing AD
- Low and stable inflation
- Low unemployment
- reducing business cycle fluctiations
- long term economic growth
Nominal interest rate vs Real
The interest rate quoted by commercial banks. If you borrow $100 at a 9% interest rate, you will pay $9 in interest.
The interest rate with inflation taken into account
Expansionary vs contractionary monetary policy
Monetary policy is a way for the central bank to control the economy by changing the amount of money in circulation and the interest rates. Governments use an expansionary policy to increase aggregate demand Y and a contractionary policy to reduce aggregate demand Y
Expansionary : lower the interest rate → reduced borrowing cost → increased consumption and investment → increase the money supply → lower interest rates → higher prices
→ increased economic growth
Contractionary: increased interest rates → higher borrowing costs → decreased consumption and investment → decrease in money supply → higher interest rates→ lower prices → decreased economic growth
Explain the role of interet rate in monetary policy
hanges in the central bank’s base rate directly affect all borrowing and lending in an economy, which affects (I) and (C) of the aggregate demand formula. For example, when the economy is functioning at a lower level than full employment, the central bank may lower interest rates in order to incentivize investing (I) and consumption (C) . Thus, helping the economy grow, show by the diagram. On the other hand, if the interest rates are increased, it will shift the aggregate demand curve inward. Y
How monetary policy fixed recessionary/deflationary gap
A recessionary gap is when the economy slows and operates below full employment. This is shown by diagram 3 where the economy is working at Y1 and P1. So, the central bank may intervene to increase the money supply and thus the money circulation in an economy. This would lower the interest rate (price of money) and incentivize firms to borrow more money to invest (I) and encourage consumers to increase their spending,increasing consumption C of the aggregate demand formula. The clear increase in aggregate demand is demonstrated by the shift from AD1 to AD2, Y showing how the economy grows and the recessionary gap is closed as prices increase from P1 to P2 and GDP increases from Y1 to Y2.
How the gvt closes inflationary gap
Contractionary Monetary policy
When the economy overheats and generates above full employment, there is an inflationary gap. It creates upward pressure on the price level, which makes it difficult to create confidence and certainty in the economy. At Y1 and P1 the economy is facing an inflationary gap. To close it, the central bank will use a contractionary monetary policy. Y This would decrease the money supply and reduce the quantity of money circulation in an economy thus increasing the interest rates. The increase of the interest rates discourages (I) investment which decreases the aggregate demand from AD1 to AD2. Tis decreases the price level from P1 to P2 and therefore closes the inflationary gap, decreasing the real GDP from Y1 to Y2.
Fiscal Policy
GVT intervenes
government expenditures and/or taxes to manage the economy
Balanced gvt budget: where government expenditure = tax revenue
Goals
- low inflation
- low unemployment
- long term grwoth
-reduding business cycle fluctations
- equitable distribution of income
- externak balance
Expansionary fiscal policy
Increase gvt spending
Decrease taxes
To stimulate the economy
Recesion at Y1 which leads to increase in consumption and increase in GVT spendiing
shifts AD1
closing an inflationary gap fiscal policy
hen the economy overheats, demand pull inflation
Using contractorary fiscal policy
increase taxes or reduce goverment expenditure to cause AD to shift inwards
Summary between New Classical and Keynesian AD
Difference between expansionary and contractionary fiscal policy
