Macroeconomics: 3.1-3.6 Flashcards
What is macroeconomics?
Studies the behavior of the national economy
- total output
- average price level
- level of employment
- distribution of income
- trade
- government policies
Describe the circular flow of income model.
Open economy with government
- households/firms inject investment, leak savings
- gov injects gov expenditure, leak taxes
- international trade injects exports, leak imports
Outline the 3 approaches to derive national income.
- Expenditure Method
- Value of all spending on the final goods and services in the economy
- Output Method
- Calculate the value of all final goods and services (goods not being used for further production) provided by the economy
- Income Method
- Add up all income earned by the factors of production
(i.e. add up all wages, rent, interest and profits)
Define GDP.
Value of goods and services produced within the country, regardless of who owns the factors of production
Define GNI.
Total income received by residents of a country, regardless of where the factors are located. (GDP + income from abroad - income paid abroad)
Nominal GDP V.S. Real GDP
Nominal GDP is measured using current market prices.
Real GDP is measured using constant prices.
Therefore, nominal GDP would be affected by the
changes in price level while real GDP does not.
Real GDP allows better comparisons
Equation of price deflator
Nominal GDP / Real GDP x 100%
Outline the limitations of GDP/GNI
- Cannot accurately measure the true value of output (non-marketed output e.g. growing own food/parallel markets, negative externalities)
- Cannot accurately measure economic well-being (e.g. distribution of income, quality of life factors)
Outline alternative measures of well-being
- OECD better life index
- Happiness index
- Happy planet index
Define recession.
two successive quarters of
negative economic
growth
Define aggregate demand.
The total demand for all goods and services in an economy over a period of time at different general price levels
AD = C + I + G + (X-M)
Outline how AD is affected by the price level.
- Wealth effect: decrease in PL leads to a higher purchasing power of money
- Interest rate effect: a fall in PL leads to a drop in interest rates which increases the demand for money
- International trade effect: fall in PL leads to more exports and increases C and I
Define aggregate supply
The total planned national output being produced at different price levels.
Outline characteristics of Monetarist curve.
- Gov intervention destabilizes things more than they help
- Significant difference between short run and long run
- In the short run, wages and factor prices are sticky due to labour contracts or minimum wage
Outline why SRAS curve shifts.
Any factors affecting the cost of production for firms
- Changes in resource prices - price of raw materials
- Changes in indirect taxes
- Changes in subsidies
- Supply shocks (e.g. war, natural disasters)
Outline what is long-run aggregate supply.
- shows full employment level of output
- this output level is the potential GDP (optimal and stable output)
How does the inflationary gap self-correct in the Monetarist model?
- AD increases
- in the short run, firms increase output
- Inflation is slower to realize
- When realized, workers urge for pay rise
- cost of production for firms increases
- SRAS shifts to the left
- Back to potential output at a higher price
Outline reasons for LRAS shift.
Quantity or quality of factors of production changes
- Improvements in efficiency
- introduction of new technologies
- changes in working population or labor quality
- institutional changes - better infrastructure etc.
Describe the Keynesian model.
- Assumes no difference between short run and long run
- Wages and product prices have downward inflexibility
Outline the 3 sections of the Keynesian curve.
Three sections
- Recession with low output, high unemployment and spare capacity
- No more spare capacity as employment of resources increases, economy reaches potential output
- Real GDP can no longer increase as firms are using the maximum amount of resources
Define unemployment
People of working age who are willing to work and are actively looking for a job but are currently without a job
How is unemployment rate measured?
Unemployment rate = Number of unemployed / Labour force x 100%
Define labour force
The number of employed + unemployed
Excludes
- Dependent population (children, retired persons)
- Adult students
- Disabled/ill
Outline why there are difficulties in measuring unemployment.
Underestimation
- Hidden unemployment: Discouraged works/People without jobs under retraining
- Underemployment: People who want to work as full-time but work as part-time/People with jobs that don’t make full use of their skills
Overestimation
- Jobs in the underground (informal economy)
- Unregistered/unregulated/unreported jobs
Unemployment disparity among different population groups
- Regional
- Gender
- Ethnic
- Age
Outline the consequences of unemployment.
- GDP: Loss of real output (less than maximum potential output)
- Workers: Unemployed, loss of income
- Gov: Loss of tax revenue, burden on unemployment benefits, less able to provide public/merit goods
- Distribution of income: more income inequalities
- Social: stress, crime, indebtedness, social deprivation
Outline the types of unemployment.
Natural
- Frictional: workers are between jobs
- Seasonal: demand for labour in certain industries changes on a seasonal basis
- Structural: mismatch of D&S for labor (e.g. changes in demand for particular labor skills/changes in geographical location of industries)
Unnatural
- Cyclical: demand-deficient, occurs during recession
Define inflation.
The sustained increase in the general price level for the goods and services in an economy
Outline how is inflation calculated.
Consumer Price Index = Value of basket in a specific year / Value of basket in the base year x 100%
Outline the problems with the CPI.
Based on the same basket of G&S and weights to reflect consumption by the typical households - cannot account for new and old products/change in quality
Outline types and causes of inflation.
Demand-Pull inflation
- Increases in AD by changes in determinants of AD
- AD = C+I+G+(X-M)
Cost-push inflation
- Increases in costs of production/supply-side shocks
Outline consequences of inflation.
- Menu costs: firms need to update price lists regularly
- Shoe leather costs: fluctuations in price levels causes customers to spend more time searching for the best deals - opportunity cost
- Consumers face reduced purchasing power
- Savers/Lenders lose out as the real value of money decreases
- Borrowers gain since money needed to repay is worth less
- Reduced international competitiveness: foreigners are less willing to buy exports
- Increased prices of imports
- Low confidence due to uncertainty of the future
- Wage-price spiral: trade unions negotiate higher wages, but fuels inflation as firms raise prices to maintain profit margins
- Inefficient resources allocation
Define deflation.
The sustained decrease in the price of goods and services in an economy over a period of time
Describe the deflationary spiral.
- Less spending as consumers expect prices to keep dropping
- Borrowing from consumers and producers is discouraged
- AD falls —> cyclical unemployment increases, incomes decrease, spending decreases even further, prices fall even further
- May lead to bankruptcies or financial crisis
Define economic growth.
The increase in real GDP over a period of time
Define equality.
- The extent to which income is distributed equally
- Everyone is paid equally, no inequalities exist
Define equity.
- Income distribution which is fair
- those with higher levels of qualifications should be paid more, so justified inequalities exist
Outline how the Gini coefficient works.
- Derived from Lorenz curve
- Summary measure of income inequality
- Scale of 0 to 1: 0=perfect income equality; 1=perfect income inequality
Define absolute poverty.
People who live with income level less than the extreme poverty line (cannot meet basic physical needs)
Define relative poverty.
People who cannot afford goods and services that are typical in the society, compares income of individuals with the median income
Outline the difficulties in measuring poverty.
- Definition of poverty is inconsistent
- Indicators use different criteria for measurement
- Ignore wealth, saving, investments —> over/underestimation
Outline the causes of economic inequality and poverty.
- Limited income - inequality of opportunity, different levels of human capital, unequal status/power
- Discrimination - gender, race, disability
- Gov tax and benefits policies
- Globalization and technological changes
Outline the consequences of income inequality and poverty.
- Low living standards
- low economic growth
- lack of education
- lack of healthcare
- social problems - higher crime rate, drug use, homelessness
Outline methods to redistribute income.
- Transfer payments - direct payment to vulnerable groups
- Gov provision or subsidies on G&S
- Gov intervention: price controls
- universal basic income
- policies to reduce discrimination - legislation, education
- taxation
Define green GDP.
Measure of GDP that accounts for environmental destruction of economic activity by deducting the environmental costs associated with the output of goods and services
Compare GDP and AD.
- GDP: value of actual expenditure in the economy over the year
- AD: planned expenditure in a given time period
Define disposable income.
Earnings after taxes have been accounted for, i.e. the actual take-home income that workers are able to spend
Outline factors that affect the level of consumption.
- Consumer confidence
- Interest rates: higher interest rates discourage borrowing, reducing consumption
- Wealth
- Personal tax income
- Household indebtedness
Outline factors that affect the level of investment
- Interest rates: higher interest rates discourage borrowing, reducing investment
- Business confidence
- Technology
- Business taxes
- Corporate indebtedness
Outline why Keynesians argue that wages are “sticky”
- Firms prefer to cut employment rather than wages because pay cuts can reduce worker morale and productivity
- Existing employment contracts
- Not legally possible to cut wages below the national minimum wage
Define deflationary gap
Exists when real national output equilibrium is below the full employment level of output - shortfall of actual output from potential output
Define inflationary gap
Exists when actual national output exceeds the full employment level of output - actual output exceeds full employment output
Outline government policies to deal with unemployment
- Frictional: improving information services to aid job seekers
- Seasonal: improve skills of the seasonally unemployed by policies that improve education and training
- Structural: broader range of vocational training programmers, greater access to university courses
- Cyclical: expansionary fiscal/monetary policy to stimulate economic activity
Define disinflation
When there is a fall in the rate of inflation rather than an actual fall in the general price level
Is inflation always bad?
- Low rates are usually not harmful since higher prices encourage firms to supply more output
- Only when it rises too quickly can it disrupt decision making for households, firms, governments
Explain Benign deflation.
- Caused by higher AS (increased productive capacity of the economy)
- Boosts national output and employment
- Non-threatening deflation caused by higher productivity or technological progress
Explain Malign deflation.
- caused by leftwards shift of AD curve
- associated with an economic recession and rising levels of unemployment
- harmful to the economy
Outline consequences of malign deflation
- Cyclical unemployment
- Bankruptcies: consumers spend less, firms suffer from lower sales revenues and profits, more difficult to pay debts
- Lower investment expenditure
- Rise in real value of debts: real value of money rises
- Government debt
- Declining confidence levels —> Downward deflationary spiral
Outline causes of economic growth
- Factor endowments: quantity and quality of a country’s FOP
- Discovery of raw materials
- Increase in size and skills of labour force
- Mobility of labour: Occupational/geographical
- Labour productivity
- Investment expenditure
Outline consequences of economic growth
- Higher standards of living
- Lower levels of unemployment
- Danger of demand-pull inflation
- Greater disparities in income distribution
- Greater tax revenues for the government
- Current account of the balance of payments improve
- Problems for sustainability: resource depletion, pollution, congestion
Outline causes of poverty
- Low income: unable to meet basic needs
- Unemployment
- Overpopulation: GDP per capita declines
- Gender/race inequalities
- Corruption and conflict
- Lack of natural resources
- Natural disasters
Outline progressive, regressive and proportional taxation.
- Progressive: charges higher percentage tax as an individuals’s income rises
- Regressive: charges greater proportion of tax on lower-income earners
- Proportional: charges same flat rate percentage tax
Outline measures to promote equity
- Subsidies: firms provide socially desirable G&S to redistribute income
- Transfer payments: old-age pensions, unemployment benefits, child allowances
