Macro Year One Flashcards
Characteristics of a capitalist society
Producers don’t own their output or means of production
Production is for profit
Monetary in nature
U/e is possible unlike slave societies
Intensive- child mining, gardening
Extensive expansions
Characteristics of Feudalism
Barter economy
Economic self-sufficiency
Catholic philosophy predominant- trading/ profit sin
Econ order on of tradition
Very slow technical change – no growth
Transition to Capitalism
Enclosures: system which the lords enclosed common land for their own use rather than public use
Observational equivalence
it’s not always possible to differentiate between alternative models which give rise to policy debates.
Positive Analysis
analyses the economic consequences of a particular event or policy not whether it was desirable
Normative Analysis
whether the policy should be used (involves the value of the person doing the analysis)
Classical Approach+ result
Economy works well on its own
‘invisible hand’ idea means that if markets are free individuals conduct their economic affairs in their own self-interest- the overall economy works well
Wages adjust rapidly to reach an equilibrium
Changes in wages signal for people to coordinate behaviour
RESULT: government should have a limited role in economy
Keynesian approach
Classical failed as unemployment and inflation were high (the great depression)
Persistent u/e as wages and prices adjust slowly
CONCLUSION- govts should intervene to reach full employment
Why a barter economy is inefficient
Only efficient when there are very few goods
The need for a double coincidence of wants which is unlikely in practice due to billions of goods/ services and buyers/ sellers
Money needed as a medium of exchange and store of value fundamental to facilitate trillions of transactions and therefore the macro economy
The circular flow model of Quesnay
Francois Quesnay divided the French society into 3 classes
Landlords- draw rent from the land
Artisans- spend what they earn
Farmers- save for investment
Why the Quesnay model was not used by successive economists
The classics had a much broader definition of productive workers- including artisans and industrial workers not just farmers
It took a static view of the economy when economic growth was the main concern for the likes of Smith and Ricardo
What does consumption depend on according to Keynes
Disposable income
What does consumption depend on according to Friedman and Modigliani
Lifetime income i.e. parents may save for later consumption
Outside wealth
held by agents in the private sector of the domestic economy but are issued by an agent in another sector usually govt or overseas sector
Inside wealth
an asset issued by an agent in the private sector and held by another agent
Income expenditure diagram
Check L9
Income expenditure and net exports diagram
See macro L9
The output measure of national income
Add up all the output produced by firms in the economy
How do we get from Gross value added (GVA) to GDP
Add indirect taxes and deduct subsides
The income method of output measure
total of all income in an economy (wages, operating surpluses and mixed income)
Expenditure method of output
expenditure on the output of firms
Economic welfare
welfare gained from the consumption and production of goods and services.
Business cycles
Peak
Recession
Trough
Recovery
Great depression stats
u/e reached 2 million in 1922 and peaked in 3 million (22%) in 1932
Cause of great depression
J.A. Hobson identified the cause as ‘over production’ savings to high as a result of uneven dist of income.
Economists’ response to great depression
Argued the economy was fundamentally sound and should be left and nothing should be done (Robbins and Schumpeter)
Keynes argued that effective demand was the key to employment
Temp assumptions Keynes
Industrial structure of economy is fixed
Firms output is aggregated into a single productive sector producing homogeneous output
Price level is fixed
All variables measured in real terms
The consumption function
C is positively related to Y
The consumption function formula and implication
C=α+BY where α is autonomous consumption and B is ΔC/ΔY or MPC the change in consumption is less than the change in income as mpc is smaller at higher levels of income
Savings Function Formula
S=Y-C=α+(1-B)Y
Where B is ΔC/ΔY
α is autonomous consumption
APS
average propensity to save
MPS marginal propensity to spend
The fraction of any increment to GDP to be spent on domestic output
Intensive growth vs extensive growth
Extensive total increase in GDP Intensive- GDP per head
Schumpeter view on long term growth
Caused by periodic bursts in innovation the irregularity of which cause the long term cycles of growth
4 Determinants of growth
- Growth in the labour force
- Investment in human capital
- Investment in physical capital
- Technological change,
3 forms of investment
Inventories
Residential house construction
investment in fixed capital
Features of desired investment spending
most volatile GDP component
Negatively related to the rate of interest- Keynes believed business expectations were more important
Marginal propensity to spend
the fraction of any increment to GDP to be spent on domestic output
Aggregate expenditure diagram
L6
Model to show the fall in investment impact on income
L7
Net taxes=
Tax revenues-transfer payments
Tax function
T=t0+TY
t0 exogenous (tax not related to income)
Diagram to show a budget surplus
L7
Fiscal policy
Discretionary changes in G and T
Limitations of Fiscal policy
Time lag
Financing issue
EU tries to limit budget deficit to 3% of GDP
Export definition and determinants
Goods and services made in UK sold abroad
Depends on the level of foreign income and price competitiveness of foreign goods
Import function
IM=m0+mY
where m is the marginal propensity to import
and m0 is exogenous price competitiveness
Net export function
NX=X-m0-mY=x0-mY
Graph showing relationship between imports and exports with income
L7
Shifts in net exports
Rise in foreign GDP demand for exports increase causes NX to shift upwards
Relative international prices
Change in relative price of home-produced goods relative to foreign goods
Full open economy multiplier with government
=1/1[1-b(1-t)+m]
How does the open economy multiplier differ to the closed one
Smaller since m>0
Private sector multiplier+why
1/1-b
Substituting the consumption function into the equilibrium condition gives
Y=a+bY+I
or Y(1-b)=a+I
/1-b= Y=1/1-b
Consumption function with government sector
C=a+b(y-t)
substitute tax revneue= T=t0+tY
=(a-bt0)+b(1-t)Y
Multiplier with government sector
1/(1-b(1-t))
Diagram to show the addition or government sector to aggregate expenditure
L7
Factors that effect the level of money wage rate
employment level and price level
expected real wage rate equation
W/p^e=f.NZ
W(money wage rate)/p^e(expected future price level)=f(depends on)(N(employment)z(trade union or u/e benefits)
how to get from expected real wage rate to actual real wage rate
Both sides of equation need to be multiplied by P^e/P
w=W/P=(P^e/P)f(N,z)
What does the real wage function tell us
real wage rate is a positive function of employment and institutional factors and the ratio of expected future price level to the actual price level
Thus unexpected rises in the price level reduce real wage rate
price setting equation and what this means
P=(1+µ)W
µ constant mark up
Money wage costs(W)
Since µ>0 prices exceed unit costs by extent of the mark up
Which means firms set prices independently to demand
price setting equation in terms of real wage rate
W/P=1/(1+µ)
Real wage rate to employment diagram
L10
Interpretation of real wage rate to employment diagram
N0 is employment consistent with price setting behaviour
N0=NRU
Increase in markup firms increase prices leads to decrease in real wage
Or this would have minimal impact since you only consume a small amount of goods consumed by your firm but if all firms increase mark up RW declines
Neo classical production function
Y=Φ N
N=labour
Φ=output per head or productivity(ΔY/ΔN)
Wage setting equation
W/P=(P^e/P)f(Y/Φ Z)
How to get from the wage setting equation to the aggregate supply one
substitute for W/P using the price setting relation=1/(1+µ)=(P^e/P)f(Y/Φ Z)
or
P=P^e(1+µ)f(Y/Φ Z)
What does the aggregate supply relation say
PL and output are positively related
increase in µ or z or fall in Φ lead to the AS curve shifting up as p rises at each output
what happens if P=P^e with relation to AS
level of output is at the natural rate or the LRAS
Diagram to show relation of the SRAS cruve and price/wage setting
L10
Why is there a relation between the SRAS and price/wage setting
AS curve relates real GDP to P
along AS curve price/wage setting behaviour are consistent
rise in markup indicates more monopoly power and shift up in AS
Rise in productivity downwards shift in SRAS
Rise in Z upward shift in SRAS
Combined AD/AS diagram
L10
AD/AS what if P<P0 (equilibrium) or if P>p0
If P<P0 then desired spending is consistent with a level of GDP that is greater than the desired output of firms
If P>P0 then desired spending is consistent with a level of GDP that is less than the desired output of firms
Why investment continues to rise with GDP rather than one permanent increase in I
The accelerator
Availability of funds
Expectations
Floors and ceilings
Ceilings- caused by tight constraints on input prices cause GDP to slow reducing investment causing expectations to turn
The floor- low level of GDP households use up savings or go into debt to sustain lifestyle U/E benefits limit downturn
Issues with the claimant count measure
As the benefit system changes number of claimants change
Those not on benefits not counted
Counts anyone with 2 jobs twice
ILO unemployment categories
ILO employed- at least one hour work per week or on job training scheme
Unemployed- either out of work or have not tried to find a job for 4 weeks or who will start a job in the next 2 weeks
Economically inactive- everybody else
Economic growth
the rate of change in real GDP per capita over a long period of time
3 perquisites for economic growth Classical (Smith)
Security of property was necessary for the supply of effort and capital
Control of primogeniture- control wealth to give to one person as divided land is not as productive
Infrastructure provided by the state
The division of labour classical theory of growth (Smith)
Wealth of nations emphasised that the productivity of labour depended on the extent of division of labour
This is through:
Work force improves with practice
Time saved moving between tasks
Machinery can and should be employed
Issues with smith’s view
Smith assumed that extra population from economic growth would lead to more output- this may not generate more income per head thus reducing welfare for individuals
Malthus theory of population
Assumed population rose with geometric progression whilst food grew arithmetically
Unless population is checked population would outweigh food supply
Population growth had to be restrained below potential by checks on birth rate
Malthus population diagram
L13
Ricardo growth theory
Based on the AP and MP of land
TP divided into 3 classes landowners, capitalists and peasants
It is the marginal strip of the land that determines the rental value of all more fertile land
As less fertile land was used to feed the growing population- rents increased but given subsistence wages profits were squeezed
Eventually there were no profits and no growth since capitalists re-invested surplus
If corn laws were abolished growth would continue as food could be imported
Increased capital-more output-more population-higher demand more food
Fertile land is scarce-less fertile land used to feed population price rises as well as rent rises
Profits would be so low- no incentive to invest- growth ends
Ricardo diagram
L13
Marx views
Profits were the results of capitalists exploiting workers
Capitalists buy labour power at its value- cost of workers subsistence
This is less than the value of commodities capitalists left with a surplus
Marx assumed the organic composition of capital- ratio of fixed capital to that used to employ labour would rise steadily with increased mechanisation as capitalists substitutes men to machines
For a constant rate of exploitation (profits/wages) than the rates of profits (profits/capital stock must fall)
Capitalists try to increase the rate of exploitation by innovating- increasing length of working day and pushing wages down
The result is a rise in the industrial reserve army (unemployed)
Modern approach to growth
Savings is a function of income S=sy
Investment
Defined as I= ΔK+ δK or new investment Δk+ depreciation δK
To reach equilibrium K/N or capital per worker must be kept constant
This is dependent on: depreciation rate and rate of growth for workers
Long run equilibrium: ΔK=i-(δ+n)k=0 or capital per head = investment per worker- depreciation + workers =0
Sorlow swan model
L13
Costs of economic growth
Personal costs- a growing economy is a changing economy is a changing economy which means continual relocation of resources making skills obsolete
Distribution costs
Time distribution- costs of future growth are today while benefits are reaped bt next generation
Geographical- there are often regional and national losers and gainers from economic growth
Negative externalities
Increased pollution
Congestion
Growth and happiness
Working longer hours reduces leisure time
1960s USA happier than 2000s despite real incomes doubling
Resource exhaustion
Since 1945 rapid acceleration in the consumption of the world’s resources
But typical innovation in production uses less of all inputs per unit of output
Conclusion
Economic growth has raised the average citizen of advanced economies from poverty over 200 years but yet there is still poverty which exacerbates negatives of economic growth
Further growth must be sustainable
No guarantee that the world will solve its problems of sustainable growth
GNP
value of income that its citizens earn from whatever countries this income is derived.
GNI
GNP- any foreign income not repatriated during the period
Value added=
gross output minus value of input goods used up to make output
GDP deflator =
nominal gdp/real gdp
Okun’s law
even once changes in AD and Labour D has changed employment u/e will not be reduced by the same amount. In a slump those u/e become discouraged and leave the LF thus a smaller change in measured U/E. In a boom those outside the LF may be encouraged to join or rejoin thus changed employment may not change u/e
Macro short run
disequilibrium
Long run
equilibrium once automatic stabilisers have had an effect
Desired spending
refers to what people want to spend out of the resources that are at their command
Household spending as a percentage of GDP Uk 2017
63%
Average propensity to consume (APC)
total consumption spending divided by total disposable income
Marginal propensity to consume
change in consumption by the change in income
Consumption function axis
y desired consumption spending x real income
What does the 45 degree line show on the consumption function
connects all lines where desired consumption equals actual consumption
Real wage puzzle
during recession firms hire fewer labour so MP of each labour rises thus wages should rise but they don’t
Accelerator model of investment
higher expected output raises expected future profits and raises demand for investment in new capacity
market clearing new classical
Very fast
market clearing: gradual monetarist
Quite fast
market clearing: moderate keynesian
Quite slow
market clearing extreme keynesian
Very slow
Expectations adjustment new classical
Rapid
Expectations adjustment Gradual monetarist
slower
Expectations adjustment moderate Keynesian
Fast or slow
Expectations adjustment: extreme Keynesian
Slow
Long/short run: new classical
Little difference
Long/short run: Gradual monetarist
Long run more important
Long/short run: Moderate Keynesian
Don’t forget short run
Long/short run: Extreme Keynesian
SR vital
Full employment: new classical
Always close
Full employment: Gradual monetarist
Never far
Full employment: Moderate Keynesian
Could be far
Full employment: Extreme Keynesian
Could stay away
Hysteresis: New classical
No problem
Hysteresis: Gradual monetarist
No problem
Hysteresis: Moderate Keynesian
Might be a problem
Hysteresis: Extreme Keynesian
Problem
Demand management or supply side policy: New classical
Forget demand supply side needed
Demand management or supply side policy: Gradual monetarist
Supply more important but avoid swings in demand
Demand management or supply side policy: moderate Keynesian
Demand matters too
Demand management or supply side policy: Extreme Keynesian
Demand is what counts
Neo-classical sources of growth
Labour force growth
Physical capital
Human capital
Neo classical approach to labour force growth
As more labour is used, there will be more output and, consequently, a growth in total GDP. The law of diminishing returns tells us that sooner or later both the marginal and average product of labour will begin to decline so although economic growth continues in the sense that total output is growing, living standards are falling in the sense that average GDP per head of population is falling.
Neo classical approach to physical capital
because it is output per person that determines living standards, not output per unit of capital. Thus, as physical capital increases, living standards increase because output is rising while the population is constant
Neo classical approach to human capital
Improvements to health or training
Why investment may actually have increasing returns
Investment in the early stages of development of a country or region may create new skills and attitudes in the workforce that are then available to all subsequent investors at decreased cost
Each new investor may find the environment increasingly favourable to its investment because
Combination of fiscal policy and exchange rate policy
To prevent an external deficit appearing because of a fiscal expansion govt could simultaneously devalue the currency
This is dependent if there is sufficient excess capacity in the home economy to expand output if not this would just lead to inflationary pressure
Tinbergen principle
to simultaneously obtain two objectives the govt needs 2 independent instruments
Taylor rule
changes in monetary policy should be made in relation to deviations of both inflation from its target rate and GDP from its potential level.
convergence hypothesis
When capital per worker is low, it does not take much investment to equip new workers with capital (capital-widening), so the rest of investment can go on raising capital per worker (capital-deepening). When capital per worker is already high, it takes a lot of saving and investment just to maintain capital-widening, let alone to deepen capital
Endogenous growth theory
there are significant externalities to capital. Higher capital in one firm increases productivity in other firms.
Capital widening
extends the existing capital per worker to new extra workers.
Capital deepening
raises capital per worker for all workers.
What does neoclassical assume
actual and potential output are equal.
Zero growth proposal
because higher measured GNP imposes environmental costs, it is best to aim for zero growth of measured GNP.
Sterilization
An open market operation involves buying or selling domestic bonds to offset changes in the domestic money supply caused by a balance of payments surplus or deficit.
Classical theory of growth
growth mainly in terms of capital accumulation and population growth.
2 sectors agriculture and manufacturing
constant returns to scale in manufacturing
diminishing returns in agriculture where land, which was fixed in supply
Classical growth theory, combined with Malthus’s views on population, led to the prediction that growth could not raise living standards above subsistence except for short bursts associated with innovations.
What is needed for neoclassical growth
the only way for growth to add to living standards is for the per capita stocks of physical and human capital to increase due to diminishing marginal returns of capital
