Macro econplusdal Textbook Flashcards
What is the aggregate demand equation?
AD = C + I + G + (X - M)
Aggregate demand definition
The total expenditure on a country’s goods and services at a given price level in a given time period
Aggregate demand and the download slope
- Wealth effect
- Trade effect
- Interest effect
Determinants of consumption
- Level of real disposable income
- Interest rates
- Wealth (asset prices)
- Consumer confidence
- Household indebtedness
- Anticipated inflation
Determinants of saving
- The level of real disposable income
- Interest rates
- Consumer confidence
- The range and trustworthiness of financial institutions
- Tax incentives like ISAs
Determinants of investment
- Interest rates
- Business confidence
- The level of corporation Tax
- Capacity utilisation
- The rate of growth of technology and competition
- The price of capital
Governments spend money in the economy to:
- Influence the level of economic activity
- Correct marker failures and improve allocative efficiency
- To reduce inequality and promote equity
Determinants of net exports (X - M)
- Exchange rates
- Real disposable income earned abroad
- Real disposable income earned at home
- Government restrictions on free trade
SRAS
Drawn assuming the price of FOP are fixed
Determinants of SRAS
Think costs of production
- Raw material/commodity prices such as oil
- Business taxes like VAT
- Wages
- Prices of imported commodities/raw materials due to exchange rate changes
Classical LRAS
The maximum level output an economy can produce using factors of production at sustainable level. The productive potential of the economy
Keynesian LRAS
The total amount of goods and services that producers are willing and able to produce at a given price level in a given time period
LRAS determinants
- Labour productivity
- Investment
- Infrastructure improvements
- Competition
- Immigration
- The institutional structure of the economy
Macroeconomic equilibrium
Where AD = AS
Macroeconomic equilibrium (AD shift right)
- Growth: increases
- Unemployment: falls
- Inflation: DP inflation rises
- Trade position: worsen
Macroeconomic equilibrium (AS shift right). Evaluation
- The initial level of economic activity
2. The size of the multiplier
Macroeconomic equilibrium (LRAS shift right)
- Growth: rises
- Unemployment falls
- CP inflation falls
- Trade position: improve
Macroeconomic equilibrium (LRAS shift right): evaluation:
The initial level of economic activity
Negative output gap
Deflationary/recessionary gap
Where actual growth is less than potential growth
Positive output gap
Inflationary gap
Where actual growth is grater than potential growth
Deflationary gap and adjustment in the classical model evaluation
- Will wages fall?
- Time
- Is debt fuelled fiscal policy a better solution?
Real GDP
The total value of all final goods and services produced in an economy at a given price level in a year adjusted for inflation (using constant prices)
Economic growth
An increase in real GDP or an increase in the productive capacity of the economy
Benefits of using national income statistics e.g real GDP
- They can be used as a report card for a country, so economic performance over time can be analysed.
- They can use it to enact and inform economic policy
- Individuals, businesses and the government can use them to build forecasting models using e.g extrapolation
- They’re used as a benchmark to evaluate standards of living
Problems with real GDP as a measure of economic growth
- To accurately measure GDP, a lot of data is needed, all coming from varied sources. It’s inevitable for inaccuracies to exist.
- Unrecorded economic activity will mean a country’s GDP is lower than what it should be
- Double counting (using output method): final value of all goods and services measured solves problem
Problems with real GDP as measure of living standards
- Real GDP purely a single measure of living standards. Only measures income
- GDP only accounts for the quantity of output produced, no information regarding the quality of that output: to overcome, use Green GDP but politically sensitive given GDP figures can massively reduce. Also hard to calculate green GDP exactly given monetary value of negative externalities
- Doesn’t provide information regarding the distribution of income
- The composition of output produced may not provide an immediate boost to living standards e.g. Capital goods
- Often calculated by converting from local currency to US dollars to provide international comparisons in days. BUT nominal exchange rates used not real exchange rates
- Doesn’t take account of remittance income: income earned abroad by domestic workers which is often sent back to family members in the home country).
- Can misguide an increase in living standards by included profit made by MNCs
To solve issues 6 and 7 of using real GDP as a measure of living standards
GNI (gross national income) can be used.
Accounts only for income generated by a country’s FOP, regardless of location
Remittance income therefore included whilst MNC profit notes
Explains why GNI per capita preferred measure of living standards than GDP in developing countries
Causes of short-run economic growth
- A cut in interest rates (reduces the cost of borrowing, reduces the rate of return on savings, reduces monthly payments for those with tracker or variable rate mortgages, reduces cost of borrowing for firms).
- Governments could reduce marginal rate of income tax for those in lower income tax bands or increase the income tax free allowance
- Could reduce level of corporations tax
- Governments could boost spending
- The exchange rate could be weakened
Causes of long run economic growth
- Government spending on education
- Government spending on infrastructure
- Government offering subsidies or tax allowances to increase the incentive for firms to invest
- Reducing the marginal rate of income tax
- Reducing corporation tax
- Privatisation
- Deregulation
- Trade liberalisation
Causes of recession - demand side shocks
- A sudden fall in consumption caused by a housing or stock market crash
- A sudden fall in investment
- A sudden fall in spending by foreigners (or a strong exchange rate)
- A banking or financial crisis
Causes of recession - supply side shocks
- A sudden rise in the price of oil
2. A rise in business taxes like VAT
Benefits of economic growth
- A fall in unemployment
- Higher profits for firms
- Fiscal dividend for the government
Cost of economic growth
- Can accelerate demand pull inflation
- No information on output quality
- Doesn’t necessarily mean incomes increasing for all
- Rising incomes is only one aspect of improving living standards
Economic growth evaluation
- Growth should be sustainable
- Growth should be inclusive
- Growth should be sustained
Problems with using the CPI to measure inflation
- The basket of goods and services generated won’t necessarily reflect the consumption habits of all consumers in the economy
- There’ll always be issues with how quickly the basket of goods and services is changed according to changes in the consumption habits of a nation
- The CPI basket is also prone to seasonal fluctuations
Causes of demand pull inflation
- Cut in interest rates (reduces cost of borrowing, the rate of return on savings, monthly payments for those with tracker or variable rate mortgages, cost of borrowing for firms)
- Reduction in the marginal rate of income tax for those in lower income tax bands or increase the income tax free allowance
- Reduction in corporation tax
- Governments boost spending
- Exchange rate could be weakened
Causes of cost push inflation
- Raw material/commodity prices increase such as oil
- Business taxes like VAT rise
- Wages rise
- Higher prices of imported commodities/raw materials due to a weak exchange rate
Costs of inflation
- Purchasing power falls
- Menu costs
- Shoe leather costs
- Savings are eroded in value
- Anticipated inflation can create inflation spirals
- Reduced international competitiveness
- Fiscal drag
- Inflationary noise
Benefits of inflation
If at low and stable rate and caused by AD
- Encourages firms to produce more output
- Workers can receive increases in pay
- During a recession, can provide flexibility to firms
Evaluation of whether inflation is good or bad
- Demand pull or cost push?
- The actual rate
- The stability of the figure
- Anticipated vs unanticipated inflation
Deflation - negative consequences
- Delayed spending
- Reduces incentive to borrow as real interest rates always positive
- Increases the real value of debt
Deflation - positive consequence
If generated by supply-side
Evaluation of whether deflation is good or bad
- Demand side or supply side?
2. Anticipated vs unanticipated deflation
Problems with LFS measure of unemployment
- The hidden unemployed
- The economically inactive
- The under-employed
- Disparities
- Cost
Causes of structural UE
- Country losing comparative advantage in production in a given industry
- Technological advancements
- Education
- Geographical immobility of labour
Determinants of the NRU
- Excessive governsmnt intervention due to a over generous benefits system encouraged frictional, seasonal and structural UE (free market)
- Excessive labour market regulation can increase and maintain high structural unemployment (Free market)
- Under provision of transport and affordable, high quality housing infrastructure (government intervention)
- Under provision of adequate in work training schemes (government intervention)
Costs of unemployment to the economy
- Lost output
- Deterioration of government finances
- Cost to other economies
- Social costs
Cost of unemployment to the individual
- Lost income
2. Hysteresis
Benefits of unemployment
- Makes it easier for firms to find workers
- Allows workers to take time in finding suitable, rewarding job for themselves
- Unemployment can help to keep inflation under control
Evaluation of whether unemployment is good or bad
- The level of unemployment
- The duration of unemployment
- The type of unemployment
- The distribution of unemployment
Causes of income/wealth inequality
- Age
- Education
- One sector dominant and capital intensive production
- Globalisation and free movements of labour and trade
- Technology
- Ownership of financial assets and property
- Corrupt governance
Consequences of income inequality
- Higher levels of debt
- Costs to the government
- Social costs
- Lower economic growth
Causes of poverty
- Poor education and healthcare
- Recession
- Born into poverty
- Work before education
Consequences of poverty
- Low living standards
2. Poverty traps
Policies to redistribute income
- Transfer payments
- Government spending on essential goods and services
Evaluation: both cost a lot to the government - Implement or adjust income tax
Evaluation: ladder curve - A minimum wage
Evaluation: can cause UE
Evaluation of policies to redistribute income
- Level of income tax set and which tax is targeted
- State of government finances
- Incentives
- Does income inequality have to come down?
How the central bank reduces interest rates
By increasing money supply by
- Reduce the reserve requirement
- Reduce the bank rate
- Buy bonds using open market operations
Transmission mechanism
a cut in interest rates:
- Reduces the cost of borrowing
- Reduces rate of return on savings
- Reduces monthly payments for those with tracker or variable mortgages
- Reduces cost of borrowing for firms
- A weak exchange rate
Expansionary monetary policy cons
- Inflation rise
- Interest rates cannot fall below 0 (a liquidity trap)
- Can have large negative impact on saves
Contractionary monetary policy pros
- To control inflation
- To protect against credit/asset bubbles and systemic risk in the banking sector
- Make housing more affordable
- Promote more appropriate/sustainable lending and borrowing
- Encourages saving and investment
- Improves the current account balance
Contractionary monetary policy cons
- Potential economic shock
- Indebted economic agents could “fall off a cliff”
- Could detract borrowing for investment
- Strengthen the exchange rate and could deteriorate the current account position
Expansionary monetary policy evaluation
- Initial level of economic activity
2. Depends on the size of interest rate cut rates
