Macro L4, 5, 6 Flashcards
What is short run defined as and what assumption does it make?
- When money wage rates and prices of all other factor inputs in economy are fixed
- Firms aim for profit maximisation
How is SRAS curve relatively price elastic?
- Firms tend to work their existing labour force more intensively to increase output, rather than sacking or hiring more workers
- Incentives are required for this so overtime pay rate increases, which increases earnings for workers and puts up average and marginal costs per unit of output (rise in prices)
- Given constant prices for factor inputs, increase in costs are likely to be fairly small
Therefore it is price elastic
What are the determinants of SRAS?
- Wage rates
- Raw material prices
- Taxation
- Exchange rate
- Productivity
What is exchange rate?
The rate at which one currency will be exchanges for another
How does SRAS shift when wage rates increase?
- Increased costs of production
- Left
How does SRAS shift when raw material prices increase and why?
- Higher industrial costs
- Left
How does SRAS shift when tax burden increases and why?
- Costs are increased
- Left
How does SRAS shift when exchange rate increases and why?
- Price of imported goods is likely to decrease
- Right
How does SRAS shift when productivity increases and why?
- Costs of production reduced
- Right
What is a supply-side shock?
When there is a large change in taxation, raw material prices or wage rates
What does LRAS curve look like and why?
- Vertical line
- The curve is fixed as whatever the price level, there is a given level of real output
Why is given level real output considered to be fixed whatever the price level?
- There is a limit to how much firms can increase their supply due to capacity constraints
- Labour productivity has been maximised due to fixed capital equipment and max labourers hired
What is an output gap and how is this returned to normal?
- When output is below or above the trend level
- Economic forces act to bring it back
What are the determinants of the LRAS curve?
- Technological advances
- Efficiency: Change in relative productivity to competing economies
- Labour: Changes in education and skills, demographic changes and migration eg. increase in workforce leads to increased LRAS
- Changes in gov regulations eg. making it simpler to set up a company leads to increased LRAS, competition policy
- Enterprise and risk-taking –> increased LRAS if encouraged
- Factor mobility –> increased LRAS
- Economic incentives –> increased LRAS
- Institutional structure of economy –> reference to political, education + banking system, laws and framework of morality
How would a change in the relative productivity to competing economies affect LRAS?
- An increase in the UK productivity of one good relative to other world economies will encourage production in the UK
- If there is increased specialisation between economies, the LRAS of world economy will increase
Why can competition both be negative and positive for LRAS?
- Firms are forced to be more productive and find ways of producing new goods and services, increasing LRAS
- However, sometimes less competition can be beneficial as it encourages free innovation
What does shift in LRAS curve right show?
There has been economic growth
Why is it that LRAS shows the economy to be operating at full capacity?
- In the long-run product markets and factor markets will be in equilibrium, which means no unemployed resources
- Therefore economy is operating at full capacity
- Even when markets are pushed into disequilibrium by some shock, they tend to fix themselves fairly quickly, returning to equilibrium
What do Keynesian economists point out and out of what period was it developed from?
- There have been times where markets have failed to clear for long periods of time
- Developed out of experience of Great Depression of 1930s where large scale unemployment lasted for over a decade
What is long-run equilibrium and what else passes through this point on the graph
- Intersection of AD + LRAS curve
- SRAS passes through
Because the economy is operating at full capacity in LRAS, what does this mean for employment?
- Economy is at full employment
In the Keynesian model, at one point is the economy at full employment and can the economy be in equilibrium at less than full employment? (L6 p15 booklet)
-When LRAS curve is vertical (Y4)
- Yes it can (AD3)
What is the key point of disagreement between classical and Keynesian economists?
- Extent to which workers react to unemployment by accepting real wage cuts
How do classical economists believe workers react to unemployment?
- Rise in unemployment leads to cuts in real wages
- Increases quantity demanded of labour
- Decreases quantity supplied, which returns the economy to full employment quickly
How do Keynesian economists believe workers react to unemployment?
- They argued that money wages are sticky downwards
- As a result, labour market will not clear unless over a long period of time (explains horizontal line when there is unemployment + equilibrium point is only reached until closer/at full employment)
What does it mean if wages are sticky downwards?
Workers refuse to accept wage cuts
According to classical economists, what will a rise in AD (shift to right) lead to in LRAS and why?
- Rise in price level but no change in output
- LRAS is max productive capacity so no amount of extra demand will change output
What change does a rise in AD cause for SRAS? (L6 p14 booklet)
- Movement up SRAS curve (B)
- Economy now in long-run disequilibrium
Why does long-run disequilibrium actually mean and what does it cause? (L6 p14 booklet)
- Economy is now operating at over-full employment
- Firms find it to difficult to supply (eg. raw materials, recruiting labour)
- Respond by bidding up wages and other costs
- Shift to left (C) as SRAS curve is based on constant wage rates and other costs, which have now been changed
- Output falls, eventually also falls to long-run equilibrium, however with higher prices
Summarise the classical model effect of AD increase:
- Initially increase in AD increases both price + output
- Over time, prices continue increasing, but output falls
- Economy returns to long run equilibrium but with higher prices
- Effect of increase in AD is purely inflationary
In what case would the Keynesian economists agree that increase in AD has a purely inflationary effect?
- At full employment (vertical line of Keynesian model)
What effect does an increase in AD have if the economy is in depression (below full employment) according to Keynesians and why? (L6 p15 booklet)
- Increase in output without increasing prices (AD1 + AD@
2) - Because there are unused resources available
What effect does an increase in AD have if the economy is a little below full employment, according to Keynesians? (L6 p15 booklet)
Increase in both output and price level (AD3)
Circular Flow of Income
Model of the economy that shows the flow of services, factors of production and their payments around the economy
What is a closed economy compared to an open economy?
Closed economy has no foreign trade whereas the other does
What do households own and what is this?
- Wealth of the nation
- Stock of land, labour and capital used to produce goods and services
What do households do with these factors of production and what do they receive in return in what form? What can they then use this to do?
- Supply them to firms in return for income
- Incomes come in the form of rents, wages, profits, interest
- Buy goods and services
What are the three ways of measuring the level of economic activity (GDP/National income) and what are each of these?
- National output (O) –> value of flow of goods and services from firms to households
- National expenditure (E) –> value of spending by households on goods and services
- National income (Y) –> value of income paid by firms to households in return for land, labour + capital
Injection
Spending which does not come from households
What are the 3 injections?
- Investment (I)
- Gov spending (G)
- Exports (X)
Withdrawal
Spending which does not flow from households to firms
What are the 3 withdrawals?
- Savings (S)
- Taxes (T) –> taken from both households + firms
- Imports (M)
What happens if injections are greater/less than or equal to withdrawals?
- Injections > Withdrawals –> Spending increases, National income (Y) rises
- Injections < Withdrawals –> Spending falls, National income falls
- Injections = Withdrawals –> Equilibrium
