Macro foundations

Question 1

Why is it important to measure economic activity through GDP/GNI?

Answer 1

i) understand how economy’s output/income change over time
ii) make comparisons between countries
iii) formulate policies to achieve important economic objectives (low unemployment, inflation etc.)

Question 2

Explain the expenditure approach of measuring GDP.

Answer 2

Add up total spending to buy final goods and services
C + G + I + (X-M)
allows comparisons of relevant contribution of each factor to GDP

Question 3

Explain the income approach of measuring GDP.

Answer 3

Add up income earned by FOP 
rent - land 
wages - labor 
interest - capital 
profit - entrepreneurship 
allows comparisons of relative income shares of FOP and contribution to GDP

Question 4

Explain the output approach to measuring GDP.

Answer 4

Add up value (P x Q) of all goods and services produced
calculated by sector - goods (agriculture, manufacturing), services (healthcare, education, finance)
allows comparisons of relative contribution of each sector to GDP

Question 5

Why might GDP/GNI underestimate standards of living?

Answer 5

i) excludes output sold in informal sector
ii) excludes unsold output (e.g. food grown for own consumption)
iii) doesn’t consider improvements in quality of goods/services
iv) doesn’t consider standard of living factors - education, healthcare, life expectancy

Question 6

Why might GDP/GNI overestimate standards of living?

Answer 6

i) doesn’t consider negative externalities that reduce standards of living e.g. pollution
ii) doesn’t consider destruction of natural resources e.g. forests, wildlife, soil quality

Question 7

What are some general reasons why GDP/GNI are inaccurate reflections of the standard of living?

Answer 7

i) disregards composition of output e.g. high military goods, low merit goods
ii) disregards income distribution e.g. high income inequality
iii) disregards differing price levels in different countries

Question 8

Explain three measures to correct deficiencies of GDP/GNI.

Answer 8

human development index (HDI) - GNI/capita, education, health
green GDP - considers environmental damage
purchasing power parity (PPP) exchange rate - correct for different price levels between countries

Question 9

Why is green GDP useful?

Answer 9

i) corrects deficiency of GDP, didn’t consider value of negative externalities from harmful production methods
ii) raises awareness of policy makers and public of importance of clean tech, minimise damage, even improve quality/quantity of natural capital

Question 10

Define the business cycle.

Answer 10

shows short-term fluctuations in real GDP over time

Question 11

Define potential output.

Answer 11

level of real GDP produced when cyclical unemployment = 0 and unemployment = NRU, “full employment output”

Question 12

Define recession.

Answer 12

fall in real GDP for two successive quarters (6 months)

Question 13

Explain the difference between a decrease in GDP and a decrease in GDP growth.

Answer 13

decrease in GDP = fall in Y = negative growth

decrease in GDP growth = rate of growth of GDP falls, 3% to 2%

Question 14

Define aggregate demand.

Answer 14

total demand for goods and services in an economy in a year at various price levels, ceteris paribus

Question 15

Why does the AD curve have a negative slope? State three reasons.
note: when answering this q, use a diagram with one AD curve and points a and b on the curve

Answer 15

negative relationship between price level and real output

i) wealth effect
ii) interest rate effect
iii) international trade effect

Question 16

Define wealth and explain how the wealth effect causes AD to have a negative slope.
hint: explain what happens when PL rises

Answer 16

wealth = value of all assets owned, including property, savings, stocks, bonds
if PL rises –> real value of wealth falls –> people feel poorer –> spending on output falls –> upward movement on AD curve from a to b

Question 17

Define interest rates and explain how the interest rate effect causes AD to have a negative slope.
hint: explain what happens when PL rises

Answer 17

interest rates = cost of borrowing money, set by central banks
if PL rises –> consumer and firms need more money for transactions –> demand for money rises –> interest rate rises –> higher cost of borrowing –> lower borrowing and spending by consumers and firms –> upward movement on AD curve from a to b

Question 18

Define international trade and explain how the international trade effect causes AD to have a negative slope.
hint: explain what happens when PL rises

Answer 18

International trade = exchange of goods and services between countries
if PL rises –> exports more expensive to foreigners –> quantity of exports fall
also
imports cheaper to domestic residents –> quantity of imports rises
therefore, net exports (X-M) falls, there is an upward movement along AD curve, from a to b

Question 19

List factors that can increase consumption spending (component of AD)

Answer 19

higher consumer confidence
interest rates fall
wealth increases
personal income taxes fall - more disposable income
household debt decreases - consumers more comfortable spending more

Question 20

List factors that can increase investment spending (component of AD)

Answer 20

business confidence
interest rates fall
technological improvements
business taxes fall - post-tax profits rise
corporate debt decreases - firms more comfortable spending

Question 21

List factors that can increase government spending (component of AD)

Answer 21

political or economic priorities

Question 22

List factors that can increase net export spending (component of AD)

Answer 22

i) income of trading partners abroad increases - demand for country’s exports increases
ii) country’s exchange rate falls - depreciation - exports become cheaper to foreigners and imports become expensive for residents - exports rise and imports fall
iii) trade protection abroad decreases - fewer restrictions abroad for imports, therefore country’s exports rise
iv) domestic trade protection increases - more restrictions on imports - imports fall - net exports rises

Question 23

What is the assumption of the monetarist AD-AS model?

Answer 23

assumes product and resource prices are flexible to changes in PL in the LR

Question 24

What is the assumption of the Keynesian AD-AS model?

Answer 24

assumes there is no LR, as wages and other resource prices do not fall easily