Macro Economics Flashcards
Draw circular flow of income
What is the GDP?
Total income earned by the factors of production in a country, regardless the assets owner.
What is the GNP/GNI?
The total income earned by a country’s factors of production, regardless the assets location.
What is green GDP?
GDP minus environmental costs, such as pollution, measures sustainability.
What does nominal mean?
At current prices (normal index)
What does real value mean?
Adjusted for inflation
What does per capita mean?
Per head of population
Phases of the business cycle
Consequences of a business cycle recovery?
- GDP Increases
- Consumption and Investment Increases
- Unemployment decreases
- Price Level Increases
Consequences of a business cycle boom
- GDP increases less rapidly and reaches highest point.
- Consumption and Investment increases to highest point
- Unemployment decreases to lowest point
- Price level increasing
Consequences of a business cycle recession?
- GDP starts to decrease
- Consumption and investment decreases
- Unemployment is increasing
- Price level is stable or possibly decreases
Consequences of a business cycle trough?
- GDP decreases to lowest point
- Consumption and Investment decreases to lowest point.
- Unemployment increases to highest point
- Price Level remains stable or decreases
What is aggregate demand?
total demand for goods and services in an economy at a given time.
How to calculate aggereagate demand?
AD=C+I+G+X−M
Meanings of shifts and moves along AD curve
Factors that influence Consumption (C)
+ Consumer confidence
− Interest Rates
+ Wealth
+ Disposable
income
− Income tax
− Level of
household debt
Factors that influence Investment (I)
-Interest rates
+Business confidence
+Level of technology
- Business tax
- Level of corparate debt
Factors that influence Government Spending (G)
+/- Policy choices of the government
Factors that influence Net Exports (X-M)
+Income of trading partners
-Value of home currency
+Value of foreign currencies
-Level of protectionism
What is Aggregate Supply?
the total amount of goods and services that all industries in the economy will produces at every given price level. In the short run (SRAS) or in the long run (LRAS).
What doe shifts and moves along SRAS curve mean?
Neo Classical LRAS
In the opinion of neo-classical economists, producers are producing at full capacity, they cannot produce more, so a change in price doesn’t and cannot influence the LRAS. The LRAS curve only depends on the quantity and quality of factors of production. When they increase (decrease) the LRAS will shift to the right (left).
Keynsian LRAS
The Keynesian LRAS curve consists of three parts:
I Producers are producing below capacity, so they can increase output without raising the cost of a product, the average price level remains the same.
II When producers increase output even further, factors of production will become scarce, increasing the price of the product.
III Producers are operating at full capacity, they cannot increase output any further.
Determinants of LRAS
- Changes in efficiency (+)
- Technological development (+)
- Changes in unemployment (−)
- Institutional / government policy changes (+/−)
How do changes in the long run equilibrium of AS/AD work? (What steps)
- Producing beyond full capacity, leads to a dramatic increase in costs. Thus shifts SRAS inwards
- Producing below full capacity, leads to a dramatic decrease in costs. Thus SRAS shifts outwards
What is deflationary gap?
A deflationary gap is the difference between full employment and the current GDP. Vice versa for the inflationary gap
What is unemployment?
Unemployment all people of working age that are not working and are actively looking for a job.
Calculate unemployment rate
Define labour force
Everyone that can, wants to, and is allowed to work. Typically the labour force consists of all people that are currently employed + all unemployed people
Types of hidden unemployment?
- Cyclical
- Structural
- Seasonal
- Frictional
Economical consequences of unemployment
- Loss in GDP (drop in production).
- Loss of tax revenue, because unemployed people have less income to pay taxes.
- Increased cost of unemployment benefits.
- Loss of income for individuals.
- Greater differences in income distribution.
Personal Consequences of unemployment
- Increased crime rates, using crime to increase money to spend.
- Increased stress levels; worries over money
- Increased indebtedness.
- Being unable to pay for housing; homelessness.
- Family breakdown.
Cyclical unemployment cause and solutions?
Cause: Decrease in aggregate demand, causes production to go down and people to become unemployed
Solution: Demand side policies to increase AD
Structural unemployment cause and solutions?
Cause: Permanent changes in demand and supply (e.g. change in taste, advance in technology) jobs causes people in certain industries to become redundant
Solutions:
- Retraining employees
- Encourage move to other regions
- Reduce unemployment benifits to incentivise the search for a new job
- Less regulation so employment becomes easier
Seasonal unemployment cause and solutions?
Cause: Lower labour demand at certain times of year (e.g. less labour demand for waitresses in winter)
Solutions:
- Reduce unemployment benefits
- Encourage to take other jobs in the off-period
Frictional unemployment cause and solutions?
Cause: Imperfect information: it takes time to find a new job when you have left your old one
Solutions:
- Improve information flow (e.g. vacancy websites)
- Reduce unemployment benefits
Where is structural unemloyment on the graph?
Where is cyclical unemployment on the graph?
What is inflation?
Inflation a sustained increase in the level of prices
What is disinflation?
Disinflation a persistent fall in the rate of inflation
What is Delfation?
Deflation a persistent fall in the level of prices
Consumer Price Index
Economists compile a basket of goods that is representative for the economy, they then compare the cost of this basket over time. The increase in price of the basket is the inflation rate.
Consequences of inflation
- Greater uncertainty: what will prices do in the future?
- Decrease in purchasing power: people can buy less due to higher prices.
- Less savings: people want to spend money now, because it is decreasing in value.
- Damage to export competitiveness: foreign countries will buy less goods from the country that has inflation due to increasing prices in this country.
Consequences of deflation
- Deferred consumption: consumers will wait to spend money, because prices are decreasing: goods bought in the future will be cheaper.
- High level of cyclical unemployment: less consumption will lead to less production and therefore causes unemployment.
- Bankruptcies: less consumption will cause profits of firms to decline. This may result in them having to shut down.
Difficulties in measuring inflation
- Different income earners may experience a different rate of inflation when their consumption pattern is not accurately reflected in the CPI (it is an average).
- Inflation figures may not accurately reflect changes in consumption patterns and the quality of the goods purchased.
- Sudden swings in the price level of food and oil can influence CPI heavily. Economists therefore also calculate an underlying rate of inflation.
- CPI only measures change in consumption prices, while changes in producer prices are also important (the PPI does use producer prices).
Demand pull inflation (graph)
Cost-push inflation (graph)
How could the government reduce inflation?
Increase taxes / reduce government spending (fiscal policy): this will cause incomes of people to decrease, reducing spending and thus reducing demand pull inflation.
Raise interest rates: this will cause people to save more (they will get more interest) and spend less, this reduces demand pull inflation.
Reduce money supply (monetary policy): when there is less money in circulation, the value of money will increase. So less money is needed to buy something and the price is reduced.
Supply-side policies – shift supply curve to the right: (e.g. education, invest in technology etc.) this will reduce the cost for producers, reducing cost-push inflation.
What is economic growth
Percentage change in gdp
Causes of an LRAS shift
Human capital to increase productivity / skill of workers (e.g. through education).
Physical capital to increase quantity / quality of man-made resources (e.g. better machines, technological advance).
Natural capital to improve / increase the stock of natural resources (e.g. explore parts of the world for fossil fuels).
Consequences of economic growth
- Increase in living standards, due to higher GDP per capita, increase in wealth.
- Decrease in unemployment, more workers needed for the increased production.
- Possible increase in inflation; when caused by a higher demand prices may rise due to demand pull inflation.
- Possible reduction in inequality (using taxation). Governments can increase their tax revenue and redistribute more.
- Increase in exports and imports: more production may lead to a higher export potential, more demand may lead to a higher import potential.
- Possible increase in sustainability. When GDP is growing there is more money available to work on sustainable technologies / when GDP growth is caused by technological advance, part of that technological advance may be used for a more sustainable production.
- Possible decrease in environment: a higher GDP means production has increased.
- Production may be polluting the environment.
What is equity?
fair distribution of income.
What is equality
equal distribution of income.
Steps to promote equity
- Taxation (progressive, regressive, proportional)
- Direct government expenditures
- Transfer payments
Arguments in favor of redistributions
- Taxes are important revenue for the government
- Taxes can help reduce market failure (see microeconomics).
- Redistribution makes the distribution of income more fair
Arguments against redistribution
- Full efficiency can only be reached without government intervention
- Taxes may discourage people to work or engage in entrepreneurial activities
- Taxes have negative effects on growth
- Transfer payments cost a lot of money which could also be used elsewhere
Lorenz curve graph
The greater the area betwwen the equality line, the higher the unequality.
What is absolute poverty
Absolute poverty: the inability to fulfill the basic economic needs.
What is relative poverty?
Relative poverty: being poor relative to others around you.
Causes of poverty
- Low incomes
- Unemployment
- Lack of human capital, not having
- enjoyed enough education may lead to unemployment and low incomes.
Consequences of poverty
- Low living standards
- Lack of access to health care and
- education
What is fiscal policy?
Fiscal policy: government intervention by either adjusting taxes or adjusting government spending
What is expansionary fiscal policy
- Reducing taxes
- Increasing government spending
- AD increases: a move from AD1 to AD2.
What is contractionary fiscal policy?
- Increasing taxes
- Decreasing government spending AD decreases: a move from AD1 toAD3.
Fiscal policy affecrs on long term growth (LRAS)
- Government expenditure can help to create an economic environment favourable to investment. (e.g. investing money in infrastructure).
- Direct investments by the government may lead to a more efficient production (e.g. by providing companies with the means to do more research & development).
Sources of Government Revenue
- Taxes
- Sale of goods and services
- (e.g. by companies that belong to the
- government).
- Sale of state owned enterprises
Sources of Government Expenditure
- Current expenditures = recurring expenditure (e.g. wages of civil servants, interest on government debt).
- Capital expenditures = one-time payment (e.g. building a new school).
- Transfer payments = payments to citizens (e.g. welfare, pensions).
Gov Revenue > expenditures
Surplus
Gov Revenue < expenditures
Deficit
Revenue = expenditures
Balanced Budget
Affects of lower interest rates
What is monetary policy
Monetary policy: central bank intervention by adjusting interest rates or money supply
Expansionary / easy monetary policy
- Increasing the money supply, this will decrease the price paid for money (which is interest) so interest will decrease.
- AD increases: a move from AD1 to AD2.
Contractionary / tight monetary policy
- Decreasing the money supply, this will increase the price paid for money (which is interest) so interest will increase.
- AD decreases: a move from AD1 to AD3.
Responsibilities of Central Banks
- Controlling inflation
- Controlling money supply
- Influencing exchange rates
- Regulating commercial banks • Controlling interest rates
Monetary policy graph
Supply side policies
government intervention by affecting the production side of the economy
⇒ changing the quantity or quality of the factors of production.
2 types of supply side policies
- Interventionist supply side policies
- Market based supply side policies
Interventionist supply side policies
- Investment in human
capital (e.g. providing education). - Investment in new technologies.
- Investment in infrastructure.
- Policies that favour industrial companies, e.g. tax cuts, subsidies.
Market based supply side policies
- Reforming the labour market to increase flexibility, this may make it easier for companies to find the right personnel.
- Incentivise working of labourers by cutting income tax. Incentivise investment by firms by cutting corporate tax.
Advantages of Fiscal Policy
+ Positively affects growth
+ Ability to target specific sectors
+ Direct impact on AD
+ Works well in a recession
Disadvantages of Fiscal Policy
− It takes time to work (time lag)
− Can’t influence the supply side of the economy
− Negatively influences government budget
− Raise in government spending can increase interest rates
⇒ less consumption and investment (crowding out)
Advantages of Monetary Policy
+ Easy to increase interest rates
+ Interest rates can be increased step-by- step (incrementally)
+ Positively affects growth
Disadvantages of Monetary Policy
− Takes time to work (time lag)
− Doesn’t work well in a recession
− Conflict of interest with inflation targets
Advantages of Supply-Side policies
+ Positively affects growth
+ Creates employment + Reduces inflationary pressure
Disadvantages of Supply-Side policies
− Takes time to work (time lag) − Can negatively influence equity − May be politically undesirable
− May negatively influence the environment
