Macroeconomics Flashcards
What is macroeconomics?
Macroeconomics is the branch of economics that looks at the performance and behaviour of an economy as a whole, rather than as individual people, markets or businesses.
What are the labels of the axis and lines for a graph in macroeconomics?
Y axis - Price level - i.e currency $ - represented by P
X axis - Real output - i.e GDP - represented by Y
Aggregate demand (AD) - Sum of all the demand in the economy.
Aggregate Supply (AS) - Sum of all the supply in the economy
What happens when the AD shifts outwards?
- The AD shifts outward (AD – AD1) due to increase consumption.
- There is an increase in real output which shows economic growth (Output increases over time).
- Due to the increase in real output - suppliers require more workers so unemployment falls.
- As a result of the Outward shift in AD there is also an increase in price level - This represents inflation
What is the consumption function? What are the components of AD?
Consumption function – AD = C + I + G + (x-m)
C - consumption –> Total spending by consumers on domestic goods/services.
I - Investment –> The addition of capital stock to the economy. This may either be Replacement investment (spend on capital to maintain productivity) or Induced investment (Spend on capital to increase output in response to increased demand).
G - Government spending –> Gv. spending on a variety of goods/services.
X-M - net exports (exports-imports)
How does confidence influence aggregate demand?
Confidence can effect aggregate demand. If people are confident they tend to spend more whereas when they are nervous they spend less.
More confidence - More consumption
Less confidence - Less consumption
Why does consumption change?
Consumption –> Total spending on domestic goods/services.
- Changes in wealth (Not same as income –> Wealth is the value of assets people own)
Two factors influence wealth:
- Change in house prices –> increase in house prices –> feel more wealthy –> increase spending/decrease savings
- Change in the value of stocks/shares –> increase in value –> feel more wealthy –> increase spending/decrease savings
2. Changes in expectations/confidence –> Increased consumer confidence –> increased consumption.
3. Interest rates —> Mainly refers to durable goods
High interest - lower spending –> As it is more expensive to borrow.
Lower interest - high spending –> Less expensive to borrow.
Interests also impact savers
Higher interest - People tend to save more money –> Less consumption
Lower interest - People tend to spend more money –> increased consumption.
- Changes in Income (Money people earn) –> Most significant factor
- Household indebtedness - (the extent to which households are willing and able to borrow money) –> I.e. Easy to borrow + low-interest rates –> consumers are more likely to take on debt.
Why does investment change?
Investment –> The addition of capital stock to the economy –> Money is obtained via ‘retained profits or borrowing.
- Businesses buy more equipment /machinery –> due to increased pressure on existing capacity due to increased consumption (Induced investment).
- Interest rate —-> High interest –> decrease incentive to borrow/increased incentive to ‘retain profits’ in bank.
- Businesses confidence —> A lot of investment decisions are based on expectations of the future.
- Technological change –> Changes in the level of tech in the economy –> forces firms to keep up in order to stay competitive.
- Business taxes and the level of business indebtedness.
Why does government spending change?
Government spending changes depending on the priorities of the politicians and where they beleive the money is best spent.
They could either spend money on…
Education
Roads
Public services
benefits
military
etc.
What factors influence net exports?
Net exports (x-m) - Exports - imports
Exports - money that flows in / Imports - money that flows out
Exports change due to…
- Changes in foreign income
- Exchange rates –> Appreciation –> More expensive for foreigns –> decrease in exports (Visa-Versa)
- Changes in Trade policies (i.e. reduce imports by taxing them heavily - used to improve domestic economy)
- Inflation —> Higher inflation –> less competitive –> More expensive.
Imports Change due to…
- Economic expansion/changes in domestic demand for foreign goods–> increase in imports
- Exchange rate –> Appreciation –> Less expensive to import –> decreased import expenditure (Visa-Versa).
- Trade policies
- Inflation rates in foreign nations.
What is the business cycle? Annotate all the parts of the graph.
- It shows what happens to GDP over time
- It shows that GDP fluctuates - rises and drops
- The overall trend is that GDP grows over time
- Output gap refers to the distance between the trend line and the actual line (Difference between actual and potential output)
The top of the economic cycle - Boom - Postive output gap (low unemployment/high inflation)
The bottom of the economic cycle - Bust (recession) - Negative output gap (high unemployment/low inflation)
Recovery phase —> Economic expansion –> increase in demand –> increase in supply –> increase in employment –> more spending –> cycle continues.
Trough —> The point where contraction comes to an end –> Output doesn’t fall lower –> some people in the economy maintain consumption/demand for exports/ G.v spending/etc.
When is an economy considered to be in recession?
After 2 consecutive quarters of negative growth.
How do changes in confidence influence AD (Chain of reasoning)?
- Increase in consumer confidence - Period of economic growth
- Causes an increase in consumption (i.e people are more confident)
- This increases the value of C (consumption) in the consumption function.
- This leads to an increase in AD.
How do changes in interest rates influence AD (chain of reasoning)?
- Interest rate increase (more expensive to borrow / more favourable to keep money in a deposit due to the interest gained).
- Mortgage payments rise which leads to a drecrease in discretionary income. People have to pay back more for their loans. Or people rather save as it is more beneficial.
Mortgage - A loan to finance the purchase of real estate, usually with specified payment periods and interest rates.
Discretionary income - Income after paying morgage, bills (money you can use for anything).
- Drop in consumption
- Decrease the value for C in the consumption function.
- Decrease in AD
How do interest rates influence Investment/AD? (Chain of reasoning)
Investment - Money spent by buisnesses on equipment and machinery (Capital goods)
- Decrease in interest rates
- Cheaper to borrow - More borrowing
- Increase in investment
- Increase in AD
or
- Increase in interest rates
- Decrease in borrowing (more expensive to borrow)
- Decrease in investment
- Decrease in AD
What happens to investment if consumption increase?
If consumption increases, investment increases in order to accomodate the increase in consumption (factories need to increase output by buying more machinary/land etc.)
Which factor of the consumption function has the greatest impact on AD?
Consumption contributes the most to AD.
What is aggregate supply?
The total quantity of goods and services produced in an economy over a particular time period, at different price levels.
Basically, the sum of the supply curves of all industries.
What factors influence AS?
When AS changes, the potential output of the economy changes.
- Improvement in technology - increased potential output
- Education/training
- Discovery of raw materials
This is demonstrated by the PPF.
What are the two different views of macroeconomics?
- Classical view
- Keynesian
Describe the classical view of economics? What is the view based on?
Classical view
It has a long run (LR) and a short run (SR) aggregate supply curve. (LRAS/SRAS)
The long run is said to be inelastic therefore any deviation (i.e SRAS excedding the LARAS) is temporary.
The long run represents full employment within the economy.
It is based on unrestricted workings within the economy and supports the pursuit of individual interests.
Classical view beleives that output of an economy is determined by supply factors.
Describe the Keynesian view of economics?
Keynesian view
The graph has one aggregate supply curve - LRAS (L - shaped) - which represents supply in the long run.
Keynesian are interventionist therefore, they advocate for government intervention.
In their policies they place emphasis on changing AD to overcome recession and to boost the economy.
How can the position on the AD curve relative to the LRAS curve inform governments on their actions?
As you go along the LRAS curve the slope goes from elastic to a inelastic supply curve.
The position of the AD curve relative to the LRAS curve can inform governments how to intervene.
I.E.
Elastic – Increase in AD – Large increasse in output + less unemployment - minimal inflation. Beneficial
Inelastic - Increase in AD – Small increase in output + no significant change in unemployment – large increase in inflation. Not Beneficial
In what situations should keynesian view be used and in what situation should a classical view be used?
- The Keynesian view is better for viewing policies and changes in AD. Hence, it is often used more in essay style questions.
- The classical view of supply is better to represent the short run aggregate supply.
Why is deflation generally seen as not beneficial?
Some might argue that during deflation people will say ‘Cheaper is better’
However, deflation can discourage people from big purchases becuase the price of goods/services will constantly be cheaper therefore making them beleive that if they wait they can buy the good/service for a cheaper price.
This leads to a reduction in consumption — AD shifts inwards — less economic growth.
What are the main macroeconomic targets?
- Maintain steady positive economic growth - growth target of around 2.5%
- Maintain low and stable inflation rate i.e 2%
- Maintain unemployment low - around 6%
- A favourable balance of payments position (exports and imports).
- Equity (fair) in the distribution of income
- Keep government borrowing low
What are the main types of government intervention?
Demand side policies
- Fiscal policy
- Monetary
Supply side policies
-Supply side policy
What is the definition of fiscal policy?
Fiscal policy involves the government changing the levels of taxation and government spending in order to influence aggregate demand and the level of economic activity.
Taxes may be Direct (income tax) or Indirect (taxes on goods/services).
What is fiscal policy normally used for?
- Stimulate economic growth during a recession - leads to a reduction in unemployment (increase AD)
- Keep inflation low (reduce AD)
- Stabilise economic growth - avoiding a boom and bust cycle.
What are some examples of government spending and taxation? (fiscal policy)
Government spending
- Healthcare
- Military
- Education
- health/fitness/sports clubs
- unemployment benefits
Taxation
- Income tax
- Duty - import tax/excise duty
- Corporation tax
- Indirect taxes (BTW)
- Road tax
Using a chain of reasoning explain the effect of increasing taxation (fiscal policy)?
- Increase taxation - income tax
- Less disposable income for people
- Decrease in consumption
- Drop in AD - shifts inwards
- Decreases inflation and real output (high unemployment)
Using a chain of reasoning explain the effect of decreasing taxation (fiscal policy)?
- Decrease taxation/tax break
- More disposable income
- Increase in consumption
- AD increase - shifts outwards
- Economic growth - less unemployment (high inflation)
What is an expansionary fiscal policy?
Expansionary fiscal policy - Goal to increase AD
- If governments like to encourage greater consumption then can lower income taxes –> more disposable income –> more consumption.
- If governments would like to encourage greater investment, they can lower corporate tax –> higher after-tax profit –> used for investment.
- Governments can increase government spending –> improve or increase public services.
What is fiscal deficit reduction?
Fiscal deficit reduction involves reducing a budget deficit using fiscal policy.
This may involve…
Increasing taxes (Income or corporate)
Reducing government spending
What is the definition of monetary policy?
It is defined as the set of official policies governing the supply of money and the level of interest rates in an economy.
IB –> Only requires an understanding of interest rates.
When we discuss interest rates we are concerned with the central bank who change the ‘base rate’ –> Base rate impacts all borrowing/lending in an economy.
Expansionary/loose monetary policy –> Increase AD
Contractionary/tight monetary policy –> decrease AD.
Using a chain of reasoning explain the effect of reducing interest rates?
- Lower interest rates.
- Pay less for mortgages / Cheaper borrowing costs / people are less inclined to save as the return won’t be as great.
- They have more disposable income
- They increase spendings - more consumption in the economy
- AD shifts outwards.
Using a chain of reasoning explain the effect of increasing interest rates.
- Higher interest rates.
- Pay more for mortgages / more expensive borrowing costs / people are more inclined to save as the return will be greater
- They have less disposable income
- They decrease spending - less consumption in the economy
- AD shifts inwards.
Is it possible to have negative interest rates?
Negative interest rate are possible and they are often used to encourage spending as people would be losing money if they were to save money.
What is the definition of supply side policy?
Supply side policies attempt to increase the output of the economy by bringing about an increase in the quantity of the factors of production or improving the quality of the factors of production.
They can either be market based or interventionist.
What are the different types of interventionist supply-side policies?
Interventionists supply-side policies –> Not controversial as they are needed as otherwise Merit goods would be underprovided.
Long term impact - Shifts out LRAS
- Education + training (investment in human capital) - Investing in schools, universities, training institutions etc. Long term + oppertunity cost
- Research and development - Keep firms up to date with modern technologies in order to reduce production costs. Long term + oppertunity cost
Governments may encourage this by offering tax incentives –> i.e. tax credit (no tax on profits used for R&D)
It can also include the discovery of raw material.
- Investment in infrastructure - Reduces specific unemployment. Roads/ railways/ transport and communication networks.
-
Industrial policies - Tax cuts/ tax allowances/ subsidised lending - promotes growth.
i. e. It allows and acts as an incentive to invest into research and development.
What are the advantages of the supply side polciy?
- No conflict between acheiving economic growth, lowering unemployment and reducing inflation.
- Can appeal to laissez faire governments (letting things go on their own course) once a law has been changed the market can be left to its own devices.
- Training can be done by buisnesses (using tax breaks) without needing government spending.
- Research + development results in more efficient use of avaliable funds. Increased productive efficiency.
What are the disadvantages of supply side policy?
- Can take a long time to see results from education, training, research and development.
- Difficult to predict future needs e.g. training builders might be needed now but maybe it won’t be necessary for the future.
- Education, research and development is costly - High opperunity cost
Taxes are then used to raise money - unpopular decision
What are interventionist supply side policy?
Interventionist supply side governments are active governments.
i.e. government spending to….
subsidising R+D
funding state schools
University fees free of charge.
What are market/ non-interventionist supply-side policies?
Market-based supply-side policies –> Focus on allowing markets to operate freely via the interaction between supply and demand, with minimal government intervention.
‘Incentive’ is very relevant here as many policies aim to increase incentives for harder work/more productivity/more investment by firms into R&D.
I.E changing a law, red tape
Tend NOT to involve government spending.
How is an increase in efficiency represented in a graph?
Increase in efficiency shifts the ‘LR’ curve away from the axis.
Represents an increase in economic potential economic output.
What is the definition of Inflation?
Inflation is a sustained increase the general price level leading to a fall in the purchasing power of money.
How is inflation measured?
The rate of inflation is measured by the annual percentage change in consumer prices.
It is normally calculated by measuring changes in the average cost of buying a basket of different goods and services for a typical household.
Goods are weighted to reflect their importance in the average consumer’s income.
(Basket changes depending on spending patterns)
Example - UK - CPI
What are the problems with measuring inflation using a basket?
- It doesn’t represent all households. I.e. Spending patterns differ between single people and households with children
- Errors in the collection of data –> limit accuracy.
- Changes in price can sometimes be due to improvements in technology/quality, not inflation.
- New products - basket is slow to respond to new spending trends.
- Changing products makes it hard to compare different years
- Countries measure inflation in different ways
Does a fall in inflation mean prices are falling?
Fall in the rate of inflation DOESN’T euqal falling prices
Drop in inflation can represent prices rising just at a slower rate.
What is deflation?
Deflation is the persistant fall in the general price level of goods and services. The rate of inflation is negative.
What are the causes of deflation?
What is the definition of unemployment?
The percentage of the working age population who are actively seeking work and willing and able to work for the market wage rate but unable to find a job.
If you decide not to work are you considered unemployed?
If you have chosen not to work — you will not be classified as unemployed. You must be active in the labour market.
Why does the definition of unemployment only concern itself with people that are actively seeking a job?
The definition only concerns itself with people that are actively looking for a job becuase they are the people that need a job for a reason. I.E financially reasons.
This is a problem for the government as there are many consequence if people are left unemployed.
The government assumes that people that don’t have a job but are NOT looking for one, are able to support themselves (Partner that works, enough money saved up etc.)
Why are unemployment numbers lower in developing countries?
In developed countries people claim to be unemployed in order to recessive unemployment benefits.
However, some developing countries might not have benefits therefore, it is a waste of time filling in the necessary forms.
What is the labour force survey?
The Labour Force Survey (LFS) is a study of the employment circumstances of the UK population. (telephone survey)
They call a sample of people and ask them questions about their employment status.
Problem - Sample group can not reflect the entire population
What is the claimant count?
The claimant count – Number of people register at the government for unemployment benefits.
Strict measurment (you have to tick all the boxes) – If you classify you can receive benefits.
Why is long term unemployment problematic?
- Over the lung run people lose their skills.
I.E Technology is ever changing - people have to adjust.
- People lose the habit for working.
- People lose connections at the workplace/industry.
- People lose confidence.
What is underployment? Does it count towards unemployment?
Underployment – working fewer hours then a person wishes to work, or not using all of the persons skills.
I.E
- Working 3 days when a person wants to work 5 days.
- Not using all of the persons skills. Working as a teacher when your a qualified teacher.
If a individual is forced to be underemployed (not their decision) then it counts towards underemployment. If it is a choice then it is not unemployment.
What is a ‘Gig Economy’
People being self-employed but have a contract with a buisness.
I.E - Uber, deliveroo etc.
What are the benefits and disadvantages of a Gig economy?
Advantages:
Flexible - People can work when they want to
offers work to the unemployed
Lower costs for buinesses.
Disadvantages:
No secure income
no minimum wage
lack of protection for workers
What are the impacts of unemployment on individuals?
- Lower standards of living
- A decrease in the chance of future employment
- Stress and health problems caused by unemployment (No adequate nutrition, medicine, etc.)
- Loss of confidence –> Unable to find employment
- Higher debt
What are the impacts of unemployment on communities?
When large proportions of people are unemployed in a community….
- There is more disorder
- Buisnesses struggle - low demand
- Higher crime rates + vandalism
What are the impacts of unemployment on the economy?
Main –> Factors of production not used –> economy is working below it’s potential output.
- Increased crime rates
- More money spent on unemployment benefits (opportunity cost)
- Loss of tax revenue which may lead too…
- Greater pressure on taxpayers due to increased taxes to pay for benefits.
- Increased borrowing which leads to debt. - Less consumption - drop in AD - less economic growth (drop in GDP) - potential recession.
- More uneven distribution of money
Brief summary of the solutions that can be employed to reduce unemployment?
- Increase consumption - lowering interest rates (monetary) - increase AD - more jobs created.
- Decrease taxes or increase government spending (fiscal policy) – increase in AD – more jobs are created – lower unemployment.
- Supply side policy – providing education to reduce structural unemployment
- Reducing unemployment benefits - act as an incentive for people to find a job quickly
- Reducing geographical inability - facilitating transport to locations with jobs
- Government provides schemes to help unemployed to search for work.
What are the different types of unemployment?
- Voluntary
- Seasonal
- Cyclical
- Frictional
- Structural
- Hidden unemployment
What is Voluntary unemployment? How could you reduce it?
Voluntary unemployment is defined as a situation when workers choose not to work at the current equilibrium wage rate.
Due to….
- Child care
- Career break
- Waiting for a better job that is better paid
Solution:
Note - The government isn’t very concerned about these people as it is their choice no too work and this would indicate that they can support themselves financially.
- Reducing unemployment benefits
What is seasonal unemployment? How would you reduce it?
This is when buisnesses close and open during different seasons thus not providing work for the employees year round.
I.E - Ice cream sellers - unemployed in the winter
- Ski instructors - unemployed in the summer
Solution
- Encouraging people to take different jobs in the off-season –> Lower unemployment benefits/improved information
- Supply-side policies - train the workers with skills for new jobs.
What is cyclical unemployment? How could you reduce it?
Cyclical or demand-deficient unemployment.
Cyclical unemployment exists when individuals lose their jobs as a result of a downturn in aggregate demand (AD). (Linked to the buisness cycle)
High unemployment - recession
Low unemployment - economic growth
Solution
Increase AD in order to create more jobs.
For example…
Monetary policy - interest rates
Fiscal policy - taxes / government spending
What is frictional unemployment? How could you reduce it?
Frictional unemployment (search unemployment) occurs when workers lose their current job/students leave education and are in the process of finding another one. (Usually Short Term)
- Not problematic as it assumed workers are aiming to find better jobs where there are more productive –> increase the economic potential
Solutions:
- Provide better information to reduce the search time.
- Create government schemes in order to aids in peoples search for jobs
- Lower unemployment benefits.
What is structural unemployment?
Most problematic out of all types of natural unemployment.
Structural unemployment occurs when certain industries decline/close down because of long-term changes in market conditions.
Problematic —> People lack occupational mobility (skills) and geographical mobility to change jobs.
What is hidden unemployment? How could you reduce it?
This is when people don’t resgister as being unemployed becuase…
- They might have enough money
- They won’t be unemployed for a long time so they don’t bother registering.
- No benefits - LEDCs
Solution:
Create incentives to register.
Facilitate the process i.e removing red tape
What is classical unemployment? What are the different views on how it can be reduced?
A type of disequilibrium unemployment
Classical unemployment occurs when real wages are kept above the market clearing wage rate, leading to a surplus of labour supplied.
The market supplies more workers than the businesses demand.
This could be due to a minimum wage being set into place - price floor.
Solution - Controversial:
- Classical - minimise government intervention - eventually, the market will clear and settle at the equilibrium (No Trade unions/min wage)
Problem with the classical view –> Difficult to reduce union power + minimum wage important for poor and their standards of living –> more inequality.
- Keynesian - more emphasis on boosting demand to reduce unemployment.
Describe the two sector circular flow of income diagram
The circular flow of income shows how money moves through the economy. It can also be used to show how GDP is calculated.
The two sector model is a simplified model of the economy.
- Households –> People who buy the nation’s output of goods/services + owners of all the economy’s factors production.
Basically –> People supply factors and get paid.
- Firms –> hire factors of production –> to produce nation’s output.
Desrcibe the five sector circular flow of income diagram
It shows the movement of money through the economy.
It also shows the money coming into an economy (injections) and all the money flowing out of an economy (leakages or withdrawals).
The five sector model is still a simplified model of the economy.
- Households
- Firms
- Government
- foreign sector / world economy
- Financial market
What are leakages and injections - Circular flow of income?
Leakage - Money gets lost in the economy which leads to a reduction in the circular flow leading to a multiplied contraction effect in production.
Causes: Money is…
- Put aside for future spending, i.e. savings (S)
- Paid to the government in taxation
- Spent on foreign-made goods and services, i.e. imports.
Injections - Injections are additions to investment, government spending or exports so boosting the circular flow of income leading to a multiplied expansion of output.
Causes:
- Capital spending by firms, i.e. investment expenditure
- The government, i.e. (Gvt. spending)
- Overseas consumers buying UK goods and service, i.e. UK exports
When is an economy in equilibrium? What happens when the economy is not in equilibrium?
An economy is in equilibrium when the rate of injections = the rate of leakages from the circular flow.
If leakages rise above injections –> national output will fall –> as there is less income circulating through the economy –> new equilibrium.
If injections rise above leakages –> national output will increase –> as there is more income circulating through the economy –> new equilibrium.
What are the three ways to measure GDP?
Each method should yield the same result.
- Output method - Value of good and services produced in the economy (Value - minus costs of inputs)
Data is usually grouped in different production sectors –> Primary/secondary/tertiary sectors.
- Income method - Measure the value of all the incomes earned in the economy.
- Expenditure method - Value of all spending on good and services in the economy.
It includes AD = C + I + Gv. + (x-m)
What is the definition of GDP?
GDP - The total value of all finished goods and services produced in an economy during one year.
What is the definition of GNP?
Gross national product is the total income that is earned by a country’s factors of production regardless of where the assets are located.
GNI is equal to GDP plus income earned from assets abroad minus income paid to foreign assets operating domestically.
What is the definition of NNI?
Net national income - Measures gross national income (measures the final value of incomes flowing into an economy) minus the depreciation of capital.
Depreciation - Capital loses value due to wear and tear of machinery, damage to capital equipment and new technology can make machinery obsolete.
In practise very difficult to calculate depreciation.
What is the market wage rate?
The market wage rate is determined by the interaction between supply and demand for workers.
Demand curve - Shows the demand for workers by firms in an economy
Supply curve - shows the supply of workers –> total number of workers that are willing and able to work at a given price.
Aggregate Demand/Supply can also be used.
What are the 4 factors of production?
What is an inflationary gap?
Inflationary gap = situation where real GDP is greater than potential GDP and unemployment is smaller than the natural rate of unemployment. (Lower than normal unemployment).
Tends to be temporary.
What is a deflationary gap?
Deflationary gap = this is a situation where real GDP is less than potential GDP and unemployment is greater than the natural rate of unemployment
Causes of poverty?
What is the philips curve? What is the histroy behind it?
The Philips curve demonstrates the trade off (relationship) between unemployment and inflation.
For example:
High unemployment - low pressure on wages - workers can’t demand higher wages - less wage inflation. Lower production costs - Lower consumers prices - Price disinflation
Low unemployment - High pressure on wages - very few workers can demand for higher wages - Wage Inflation - High production costs passed to consumers - Price inflation
History
1945 - Fiscal demand management - general tool
AD stimulated - Recession
AD reduced - period of high inflation
They beleived that you could either have unemployment or inflation - Not Both.
1980 - Philips curve relationship broke down - No more relationship between inflation and unemployment.
Monterists + New classical critical with Philips curve.
What does the Lorenz curve show? What is the Gini-coefficient?
The Lorenz curve shows whether income is equally or unequally distributed.
X-axis –> Cumulative percentage of the total population
Y-Axis –> Cumulative percentage of the total income
The Gini-coefficient is derived from the graph.
Calculated –> Ratio between the area of the Lorenz curve and the line of perfect equality and the total area beneath the curve. (Areas ‘A’ and ‘B’ shown on the graph)
Either demonstrated as a decimal or percentage
Greater value –> more Inequality
Smaller value –> Lower Inequality
What are the three different phases of the LRAS curve?
- AS is perfectly elastic at low levels of economic activity –> Increased real output does not impact average price level –> due to “spare capacity” –> i.e. high levels of unused factors (Labour/under-utilized capital).
- AS curve approaches the potential output –> spare-capacity is used up –> factors become increasingly scarce –> High costs for factors –> increased price level.
- Economy reaches full capacity (potential output) –> impossible to increase output as all factors are fully employed –> Perfectly inelastic –> can only increased when the quantity/quality of factors increase.
According to New Classical economists, what does the economy automatically do in the long-run? If you know, explain the process?
New Classical –> An economy will automatically (without government intervention) move towards the long run equilibrium. –> Free market.
- Example 1 –> Inflationary Gap
An outward shift in AD –> economic producing higher than the potential (only in short run) –> increased competition for scarce labour/capital between firms –> shown by an increase in price level on diagram –> Cost of production increase –> SRAS shift inwards back to long-run equilibrium
- Example 2 —> Deflationary gap
An inward shift in AD –> economic producing less than the potential –> decrease competition for scarce labour/capital between firms –> shown by a decrease in price level on diagram –> Cost of production decrease –> SRAS outwards back to long-run equilibrium
Important –> Long run equilibrium level of output = Full employment level of income –> Without Gov. Intervention/Only market forces
How does one calculate the rate of inflation?
For each year you must:
- Multiply –> (Index x Weight)
- Add all the Weighted indices together to generate the average index.
- Apply Average index values to the following equation (Percentage change)
Note -> Year
[(Index for (X+1) - Index for X)/(Index for X)] x100
Labour force diagram?
