Macro L7 + 8 Flashcards
Multiplier Effect (who originated it?)
- Initial change in the injection/withdrawal can have a greater final impact on equilibrium national income
- Keynesian
Value of multiplier is known as…
Multiplier ratio
Calculation for multiplier ratio:
Change in injection or withdrawal/Change in income
Calculation for MPS:
Change in savings/Change in income
How does an increase in MPS affect national income and why?
- Multiplier ratio decreases
- Savings increase, which is a withdrawal
- Withdrawals increase
- Less spending
- Lower National income
Calculation for MPC:
Change in consumption/Change in income
What do MPS and MPC sum to?
1 (as they are oppositional processes)
Calculation for MPT:
Change in taxation/Change in income
Calculation for MPM:
Change in import spending/Change in income
Calculation for MPW:
MPS + MPM + MPT
All equations learnt in multiplier effect topic: (6)
1/1-MPC = multiplier
1/MPS = multiplier
1/MPS + MPM + MPT = multiplier
1/ MPW =multiplier
MPC + MPS = 1
MPanything = change in ……./change in income
How is inflation calculated using CPI?
- Every yr, couple thousand household asked to record their expenditure for one month to create avg basket of around 700 goods
- Prices of these goods are tracked and averaged through the Living Costs & Food Survey
- Calculate avg inflation rate w/ weighting of each item
- Index number is given
When prices are tracked how is it ensured that this is fair?
They are tracked in different areas of the country and different types of retail outlets
Why are goods weighted?
A larger proportion of income are spent on some goods than other so this must be considered
How is RPI value different to CPI value, why is this the case and therefore conclude whether CPI or RPI is more accurate?
- Tends to be above CPI
- Uses Carli index (arithmetic mean) to average diff prices
- ONS said CPI is more accurate as the use of the Carli index meant inflation was consistently overstated
To solve the issue of RPI, what was created, by who and how is this different to RPI?
- ONS produced RPIJ measure
- Use same data but w/ Jevons index (type of geometric mean)
In what other ways do RPI and CPI differ?
- CPI excludes a number of items eg. housing, council tax whereas RPI doesn’t (another reason for apparent lower CPI levels)
- RPI excludes top 4% of income earners and low income pensioners (not typical households), whereas CPI covers everyone
What are redistribution effects and what is it caused by?
- Redistribution effects are when certain groups lose some purchasing power and become worse off, whereas others gain purchasing power and become better off
- Inflation
What two factors can cause inflation?
- Too much demand
- Rising costs
In what situation is demand-pull inflation likely to occur and what is caused by?
- If AD rises w/ no increase AS
- Excess demand
Reasons for excessive increases in AD:
- Excessive consumer spending
- Low interest rates (lots of borrowing)
- Rising consumer confidence (due to rising house prices)
- Increased gov spending
- World demand for UK exports (due to boom in world economy)
- Growth of money supply
- Cutting taxes
How does money supply grow and how does it cause inflation?
- If banks increase lending, this happens
- As a result, consumption and AD increases
- Causing inflation
Wage-price spiral
Workers continue to demand high wages
What inflation may occur as a result of rising costs?
Cost-push inflation
5 major sources of rising costs:
- Increase in wages increase costs of production (wages account for about 50% of NI)
- Boom in world economy mean higher import prices for UK
- Producers raise price to improve profit margins
- Raise indirect taxes
- Increase subsidies
In a stable, growing economy what is inflation likely caused by?
Mix of rising costs and excess demand
Groups who lose from inflation:
- People who receive fixed incomes/wages
- People who receive incomes/wages that increase at a slower rate than rate of inflation
- Holders of cash
- Savers
- Lenders
Why do people who receive fixed incomes/wages lose from inflation?
As the general price level increases, people become worse off
Give examples of people who receive fixed incomes/wages
- Wage contracts
- Fixed pensions
- Fixed rental income
- Fixed welfare payments
Why do people who receive incomes/wages that increase at a slower rate than rate of inflation lose out and which groups of people does this usually include?
- Causes a fall in real incomes
- Includes all groups above w/ fixed incomes/wages & any kind of income receiver
Why do holders of cash lose out from inflation?
Real value of cash falls as general price level increases
In order to maintain the real value of savings, what must be equal for savers and why is this?
- Savers must receive a rate of interest equal to the rate of inflation
- Purchasing power lost through inflation is regained through interest
Why do some savers lose out from inflation?
If the rate of interest is lower than the rate of inflation, the real value of savings would fall
Groups who gain from inflation:
- Borrowers
- Payers of fixed incomes/wages
- Payers of incomes/wages that increase at a slower rate than that of inflation
How do borrowersq gain from inflation?
If they borrow at a lower interest rate than the rate of inflation, the real value of money that has been given back falls
Why do some lenders lose out from inflation?
They lend at an interest rate lower than inflation, which means they receive less.
How do payers of fixed incomes/wages gain from inflation?
Real value of payments fall so they do not have to give as much money
How do payers of incomes/wages increase at a slower rate than inflation gain?
They benefit due to falling real value of payments
How does uncertainty affect economic growth?
- Firms become more cautious as they are unable to make accurate forecasts of costs and revenues
- Leads to fewer investments
- Lower economic growth
How are menu costs affected by inflation?
- Higher rate of inflation
- More often firms have to change their prices
- Higher menu costs
How does money illusion have negative consequences?
- When nominal incomes increases, people feel better off even when their purchasing power has not changed
- Leads to wrong spending decisions
How does international competitiveness create problems?
- As inflation occurs more rapidly compared to other trading countries, exports become more expensive, whereas imports become cheaper
- International competitiveness of country is reduced
- Difficulties for country’s balance of payments
What is an appropriate rate for inflation and why is this preferred rather than zero inflation?
- 2 to 3%
- Zero is dangerously close to deflation, which can create serious issues
