Macroeconomics Flashcards
Economic Growth
Increase in an economy’s productive potential
GDP
The value of output produced within an economy in a time period
GDP growth
Increase in the actual output of an economy
Output gap
The difference between the actual level of GDP and full employment output
Circular flow of income
A model showing the flow of goods, services and factors and their payments around the economy
Injection
Spending on domestic output which is derived from outside the circular flow of income (i.e. Government expenditure, Investment, and eXports)
Investment
An increase in capital
Marginal propensity to consume
The proportion of extra income that is spent on goods and services
Marginal propensity to save
The proportion of extra income that is not spent
Multiplier
The ratio of a change in income resulting from a change in injection
Withdrawals (i.e. leakages)
Income which is not spent on domestic output (i.e. Tax, Savings, and iMports)
Consumer Price Index (CPI)
The official measure of inflation in the UK (excludes housing costs)
Cost-push inflation
Inflation caused by increases in firms’ costs of production
Demand-pull inflation
Inflation caused by excess demand in the economy
Inflation
A sustained rise in the general price level
Deflation
A sustained fall in the general price level
Disinflation
A falling inflation rate
Living Costs and Food Survey
Survey of households’ spending patterns from which the ‘weights’ applied to the basket of goods and services are applied
Frictional unemployment
When workers are unemployed for short lengths of time between jobs
Structural unemployment
Unemployment that arises from changes in the pattern of demand and supply in the economy
Labour force, workforce, economically active
All working-age people who are in paid jobs or looking for them
Participation rate
The proportion of working-age people who are in paid jobs or looking for them
Balance of trade
The difference in values between exports and imports of goods
Gini coefficient
A statistical measure of income (or wealth) inequality between 0 and 1 (the higher the number the higher the level of inequality)
Lorenz curve
A curve showing the extent of inequality of income (or wealth) in a society
Quality of life
A measure of the overall well-being of a person
Standard of living
A measure of the material well-being of a person
Sustainable development
Development which meets the needs of the present generation without compromising the needs of future generations
Business cycle
Regular oscillation in economic activity
Deflationary policies
Government policies which reduce aggregate demand
Demand-side policies/demand management
Government use of fiscal or monetary policies to manipulate AD
Depression (or slump)
A period in which there is a particularly deep and long fall in output
Discretionary fiscal policy
Deliberate changes to fiscal policy to influence aggregate demand
Expansionary fiscal policy
The use of tax and/or government spending to increase AD
Expenditure dampening policy
The use of tax and/or government spending to reduce AD
Fine tuning
The use of demand management policies to smooth out fluctuations in the economy
Hot money
Money flowing between financial centres in search of the highest short-term interest rate
Public sector
Central and local government and public corporations
Public Sector Net Cash Requirement
How much the government needs to borrow per time period
Quantitative easing
A monetary policy where the central bank increases the money supply by a deliberate amount by buying government bonds from banks, funds and other financial institutions
Recession
Two successive quarters of negative economic growth
Supply-side policies
Government measures to increase the productive potential of an economy
Supply-side shocks
Factors which cause the AS curve to shift suddenly to the left
Stop-go
Alternate deflationary and inflationary policies to tackle the most pressing economic problems which fluctuate with the trade cycle
Direct tax
Tax levied on income, wealth or profits
Indirect tax
A tax on expenditure (i.e. goods and services)
Appreciation of a currency
The strengthening of a currency under a floating exchange system
Depreciation of a currency
The weakening of a currency under a floating exchange rate system
Devaluation
A reduction by government in the value of its currency against another in a fixed exchange rate system
Exchange rate
The price of one currency in terms of another
Fixed exchange rate
An exchange rate pegged at a given rate and maintained by government intervention
Floating exchange rate
An exchange rate determined by market forces
Foreign exchange market
The markets where currencies are bought and sold
Forward exchange market
A market in which promises to buy or sell currency at a future date at an agreed price are traded
Revaluation
An increase by government in the value of its currency against another in a fixed exchange rate system
Real exchange rate
The price of a country’s goods relative to those produced abroad when expressed in a common currency
Formula for aggregate demand
C + I + G + X - M
Aggregate supply
Total output firms are willing and able to supply at a given price level
Black/informal economy
Economic activity not declared for tax purposes
Capital (or Capital Stock)
All inputs to production that have themselves been produced
Productivity
Output per input of a factor of production
Classical or real wage unemployment
When real wages are too high and inflexible downwards, leading to insufficient demand for workers from employers
Cyclical or demand deficient unemployment
When there is insufficient demand in the economy for all workers who wish to work at current wage rates to obtain a job
Full employment
When all workers are willing and able to work at the current wage rate are employed
Hysteresis
When a sustained period of low aggregate demand can lead to permanent damage to the supply side of the economy
Inactive population
The number of those not in work and not unemployed
Involuntary unemployment
Unemployment that exists when workers are unable to find jobs despite being prepared to accept work at the existing wage rate
Long term unemployment
<p>Those unemployed for more than a year</p>
Seasonal unemployment
When workers are unemployed at certain times of the year
Short term unemployed
Those unemployed for less than a year
Unemployment
The number of people who are actively looking for a job who are unable to find work
Unemployment rate
The number of unemployed expressed as a percentage of the labour force
Underemployed
Those who would work more if hours were available or are in jobs which are below their skill level
Voluntary unemployment
Workers who choose not to accept unemployment at the existing wage rate
Closed economy
An economy where there is no foreign trade
Income
Rent, interest, wages and profits earned from wealth owned by economic actors
National income
The value of the output, expenditure or income of an economy over a period of time
Open economy
An economy where there is trade with other countries
Wealth
A stock of assets which can be used to generate a flow of production or income
Marginal Propensity to Import (MPM)
The increase in imports divided by the increase in income that caused them (ΔM ÷ ΔY)
Marginal Propensity to Save (MPS)
The increase in saving divided by the increase in income that caused it ( (ΔS ÷ ΔY)
Marginal Propensity to Tax (MPT)
The increase in tax revenues divided by the increase in income that caused them (ΔT ÷ ΔY)
Marginal Propensity to Withdraw (MPW)
The increase in withdrawals from the circular flow (S+T+M) divided by the increase in income that caused them (i.e. sum of the MPS, MPT, and MPM)
Multiplier
The figure used to multiply a change in an injection into the circular flow to find the final change in national income - it is the ratio of the final change in income to the initial change in an injection
Multiplier effect or process
An increase in investment or other injection will lead to an even greater increase in national income
Average propensity to consume
The proportion of total income spent
Average propensity to save
The proportion of total income which is saved
Consumption
Total expenditure by households on goods and services over a period of time
Consumption function
The relationship between the consumption of households and the factors which determine it
Disposable income
Household income over a period of time, including state benefits and less direct taxes
Durable goods
Goods which are consumed over a long period of time
Non-durable goods
Goods which are consumed almost immediately
Savings function
The relationship between the savings of households and the factors which determine it
Saving (personal)
The proportion of households’ disposable income which is not spent over a period of time
Wealth effect
The change in consumption following a change in asset prices
Accelerator coefficient
The capital-output ratio
Accelerator theory
The theory that the level of investment is related to past changes in income
Animal spirits
Business confidence (the mood of managers and owners of firms about the future of their industry and the wider economy)
Capital-output ratio
The ratio between the amount of capital needed to produce a given quantity of goods and the level of output
Depreciation (of the capital stock)
The value of the capital stock which has been used up or worn out
Gross investment
The addition to capital stock, both to replace existing capital stock which has been used up and the creation of additional stock
Investment
The addition to the capital stock of the economy
Net investment
Gross investment minus depreciation
Retained profit
Profits kept back by a firm for its own use which is not distributed to shareholders or used to pay taxation
Net exports or the net trade balance
Exports minus imports
Aggregate demand
The total of all demands or expenditures in the economy at any given price
Domestic economy
The economy of a single country
Aggregate supply curve
The relationship between the average level of prices in the economy and the level of total output
Full capacity
The level of output where no extra production can take in the long run with existing resources
Long-run aggregate supply curve
The aggregate supply curve which assumes that wage rates are variable both upwards and downwards
Short-run aggregate supply curve
The upward sloping aggregate supply curve which assumes that money wage rates are fixed
Money illusion
When economic agents believe that changes in money values are the same as changed in real values despite inflation
The non-accelerating inflation rate of unemployment (NAIRU)
The natural rate of unemployment - the level of unemployment which can be sustained without a change in the inflation rate
Replacement ratio
Unemployment benefits divided by the wage an unemployed worker could receive if in work
The natural rate of unemployment
The proportion of the workforce which chooses voluntarily to remain unemployed when the labour market is in equilibrium
The Phillips curve
The line which shows that higher rates of unemployment are associated with lower rates of change of money wage rates and therefore inflation and vice versa
How do you calculate an index number?
(New Value/Original Value) x 100
What are the 3 ways to measure the value of the money within the circular flow in income?
1) National Output (O)
2) National Expenditure (E)
3) National Income (Y)
What is National Output (O)?
The value of the flow of goods and services from firms to households
What is National Expenditure (E)?
The value of spending by households on goods and services
What is National Income (Y)?
The value of income paid by firms to households in return for land, labour, and capital
What is the relationship between O, E and Y?
O = E = Y
What is the multiplier in a closed economy with no government?
1 / MPS
What is the multiplies in an open economy with a government?
1 / MPW
OR
1 / (MPS + MPT + MPM)
What factors affect consumption?
1) Income (disposable) = most important
2) Interest Rates
3) Consumer Confidence
4) Wealth Effect
5) Availability of Credit
6) Inflation
7) Composition of Households
How does the composition of households affect consumption?
Young and old people tend to spend a higher proportion of their income than middle aged people
How does an increase in the interest rate decrease investment?
1) Borrowing becomes more expensive as the interest paid on the loan increases, meaning the cost of the investment increases, decreasing the number of profitable investment projects
2) Saving their retained profit as opposed to investing it becomes more lucrative for firms
What factors affect investment?
1) Interest Rates
2) Costs of the factors of production
3) Business expectations/confidence
4) The World Economy
5) Access to Credit
6) Retained Profit
7) Government Regulations
What other economic concepts can the LRAS curve be linked to?
1) Production Possibility Frontier
2) The trend rate of growth for an economy
3) Full capacity output
Why does SRAS shift?
Change in the cost of the factors of production
Why does LRAS shift?
Change in the quality or quantity of resources
To boost the economy what policy do
(a) neo-classical economists advocate?
(b) keynesian economists advocate?
(a) supply side policies
(b) increased government spending
Which variables does the Phillips curve show the relationship between?
Unemployment and inflation
Balanced budget
A statement of spending and income plans by the government where spending is equal to its receipts
Budget
<p>a statement of spending and income plans plans of an individual firm or government</p>
Budget/fiscal deficit
When government spending is greater than its receipts in a given year (NB does not include capital expenditure) - government therefore has to borrow money to finance the difference
Budget surplus
When government spending is less than its receipts in a given year- government can now use the difference to repay part of the National Debt
Capital government expenditure
Spending by government on investment goods
Current government expenditure
Spending by government on goods and services which will be consumed in the short term plus transfer payments and interest payments
Cyclical budget position
The fiscal deficit or surplus which occurs as the economy moves through the trade cycle
Fiscal rule
A numerical constraint on fiscal variables imposed either by a government itself or by an outside body to keep the budget deficit and national debt under control
Fiscal stance or budget position
Whether fiscal policy is expansionary, contractionary or neutral
National Debt
The total accumulated outstanding public sector debt
Neutral fiscal policy
When changes to government spending and taxation leave the overall budget surplus or deficit unchanged and have no effect on AD
Progressive tax
A tax where the higher the income of the taxpayer, the larger the proportion of income is paid in tax
Proportional tax
A tax where as the income of taxpayers increases, the same proportion of income is paid in tax
Public sector net borrowing (PSNB)
The official name given to the difference between government spending and its receipts in the UK
Public sector net debt (PSND)
The official name given to the National Debt in the UK
Regressive tax
A tax where the higher the income of the taxpayer, the smaller the proportion of income is paid in tax
Structural budget position
The difference between the actual budget position and the cyclical budget position at the top of a boom
Automatic or built-in stabilisers
Mechanisms which reduce the impact of changes in the economy on national income
Cyclical deficit
The part of the fiscal deficit which is caused by government spending and taxes changing through the tax cycle
Fiscal austerity
Tax rises or government spending cuts designed to reduce a government budget deficit
Primary deficit or surplus
The actual fiscal deficit or surplus not taking into account interest payments on the national debt
Structural deficit
That part of a fiscal deficit which exists even when the cyclical deficit is zero at the top of a boom
Bank of England base rate
<p>the rate of interest charged by the Bank of England to banks to borrow money overnight - influences over rates such as savings rates and rates of interest on loans by banks</p>
Contractionary monetary policy
Monetary policy which leads to a fall in aggregate demand
Expansionary monetary policy
<p>monetary policy which leads to a rise in aggregate demand</p>
Instrument of policy
An economic variable such interest rates and government spending which is used to achieve a target of government policy
Monetary policy
The manipulation by government of monetary variables such as interest rates and the money supply to achieve its objections
Rate of interest
The price of money, determined by the demand and supply of funds in a money market where there are borrowers and lenders
What is current spending composed of?
1) general government final consumption
2) transfer payments
3) debt interest
Transfer payments
Mainly welfare payments made to individuals, such as state pension and child benefit (not included in GDP payments as payments have no corresponding output)
General government final consumption
Spending on goods and services that will be consumed in the short term
Ad valorem tax
A tax levied as a percentage of the value of goods (e.g. VAT)
Specific/unit tax
A tax levied on volume (e.g. excise duties)
Which taxes tend to be
(a) progressive?
(b) regressive?
(a) direct taxes
(b) indirect taxes
Why does tax revenue decrease after the optimal tax rate has been passed on the Laffer Curve?
1) tax evasion (illegal) increases
2) tax avoidance (legal) increases
3) ‘brain drain’ effect as workers move from high tax countries to low tax countries
4) disincentive effects in the labour market reduce revenue from income tax
Examples of discretionary fiscal policy
Change in tax rates and change in the level of government spending
Examples of discretionary monetary policy
Changing interest rates or introducing quantitative easing
What is the actual deficit equal to?
Cyclical deficit + structural deficit
What are the factors influencing the size of the fiscal position and national debt?
1) structural deficits and surpluses
2) cyclical deficits and surpluses
3) unforeseen events (e.g. floods, financial crash)
4) debt interest
What measures can be taken to reduce fiscal deficits?
1) fiscal austerity
2) wait for automatic stabilisers to kick in if only cyclical
What are the problems with fiscal austerity?
1) reduced the welfare of citizens now and in the future
2) causes a fall in GDP
3) reduced AD
Contractionary fiscal policy
Fiscal policy which leads to a fall in aggregate demand
Fiscal policy
The use of taxes, government spending and government borrowing by government to achieve its objectives
Examples of automatic stabilisers
Government spending and taxation
How does the fiscal balance change automatically over the economic cycle?
In a boom tax revenue are high and welfare benefits associated with unemployment are low as the level of economic activity is high (opposite for recession)
What is Say’s law?
States that the production of goods creates its own demand since the production creates wages for workers and income for the businessman, increasing wealth and hence demand for other goods
Criticisms of Say’s Law
1) In a recession there can be insufficient demand for goods produced (e.g. 1930s)
2) Consumers may hoard cash (e.g. in a liquidity trap or time of low confidence)
Liquidity trap
When monetary policy becomes ineffective because, despite zero/very low-interest rates, people want to hold cash rather than spend or buy illiquid assets (e.g. post-2008 interest rates fell to 0.5%)
Asset bubbles
A sustained rise in the price of a share of an asset so sharply and as such a sustained rate that they exceed the utility inate to the good. Prices can be driven because expectations of future price increases bring new buyers into the market (speculative)
Why do asset bubbles occur?
1) Hubris
2) Information failure
3) Government failure/poor regulation
4) Myopia (short-sightedness)
5) Herd mentality
6) Bounded rationality (i.e. Rationality is limited by our thinking capacity, available information, and time)
7) Greed
Multiplier formula
1 ÷ (MPS + MPT + MPM)
What are the 4 financial organisations?
1) Financial Policy Committee (FPC)
2) Prudential Regulation Authority (PRA)
3) Financial Conduct Authority (FCA)
4) Competition and Markets Authority (CMA)
Which bodies were created by the Financial Services Act in 2012 in the wake of the financial crash?
1) Financial Policy Committee (FPC)
2) Prudential Regulation Authority (PRA)
3) Financial Conduct Authority (FCA)
What is the role of the Prudential Regulation Authority (PRA)?
1) To ensure financial firms hold sufficient capital and have adequate risk controls in place
2) Supervise 1700 banks, building societies, credit union insurers and major investment firms
What is the role of the Financial Policy Committee (FPC)?
1) To improve financial stability after the financial crisis, by identifying monitors and acting to remove or reduce systemic risks - carries out stress tests
2) To support the economic policy of the government
3) Committee 13 members, including 6 BoE staff, meets 4 times a year
What is the role of the Financial Conduct Authority (FCA)?
1) Promotes competition within financial markets and ensures these markets work wells
2) Helps consumers get a fair deal, providing information on how they can complain
3) Can impose fines and bans as well as providing information to consumers about rogue firms
What is the role of the Competition and Markets Authority (CMA)?
1) To carry out investigations into mergers, markets and the regulated industries
2) To enforce competition and consumer law
3) Has attempted to introduce more competition into the banking industry by encouraging the entry of challenger banks to compete against large established commercial banking businesses
Why do financial services matter in the UK?
1) A modern economy cannot function without an effective financial system
2) UK has a comparative advantage in this sector so they are a key export
3) Major contributor to the UK economy
How do financial services boost the UK economy?
1) Makes up 7% of GDP
2) Makes up 3% of all jobs
3) Surplus in financial services trade of £44bn in 2018
4) Makes up 10% of total tax revenue
What percentage of financial services exports went to the EU in 2018?
43%
How could Brexit harm the financial services industry?
1) Currently system of ‘passporting’ enables UK firms to trade easily with the EU
2) Removal of ‘passporting’ could harm financial services
Why might Brexit not be that harmful to the financial services industry?
1) England is well positioned (time zone)
2) English is the international language
3) Has accessed economies of scale
4) Financial services rely on trust and confidence, which take time to build
5) People are risk averse so don’t want to disrupt a good relationship
What are the key aims of financial stability policy?
1) Protect against the consequences of market failure
2) Protect the interest of consumers (e.g. monopoly power, high interest rates on loans, information asymmetry)
3) Encourage confidence in the financial sector (e.g. promote LR growth, allow CB to be lender of last resort, prevent systemic risk)
Systemic risk in context of financial markets
The danger that the failure of parts of the financial system will lead to the collapse of the whole of the financial system
Examples of measures put in place to protect the banking system from systemic risk
1) Ring fencing
2) Stress testing
Ring-fence
1) A virtual barrier that segregates a portion of an individual’s or company’s financial assets from the rest
2) This may be done to reserve money for a specific purpose, to reduce taxes on the individual or company, or to protect the assets from losses incurred by riskier operations
Banking stress tests
Assess how banks can cope with severe economic scenarios, looking at resilience and whether they have enough capital to withstand extreme shocks
Ring fencing in relation to the Banking sector
Riskier activities were to be outside the ring fence in order to ensure the separation of investment banking and high street banking - put an end to ‘Casino banking’
What were some of the 2018 stress-test scenarios and did British banks pass?
1) Examples: world GDP falls by 2.4%; UK unemployment rises by 9.5%; UK property prices fall by 33%
2) All British banks passed these in 2018
How did Banks intervene to stimulate lending post-2008?
1) QE
2) Funding for lending was a scheme to enable banks to borrow cheaply from the central bank in the hope that loans to businesses and households would follower (scheme closed in 2018)
Why was a new regulatory framework necessary post-2008?
Demonstrated the existence of market failure in the baking system…
1) Moral hazard (banks through they would be bailed out by insurance and the Government)
2) Too big to fail (monopoly power) (e.g. RBS collapse would have too dire a consequence on economy)
3) Market rigging (abuse of monopoly power)
4) Perverse incentives
5) Information asymmetry (between banks and customers and banks and regulators)
Moral hazard
When an economic agent makes a decision in their own best interest knowing that there are potential adverse risks, and that if problems result, the cost will be partly borne by other economic agents (down-side protected)
What perverse incentive existed in the banking sector pre-2008?
Credit rating agency gave financial institutions a rating based on their credit worthiness but were paid by financial institutions
Capital markets
Financial markets which provide long-term borrowing and lending, usually defined as over one year (e.g. bonds)
Commercial banks
Banks that provide services to businesses
Derivatives
A financial security with a value that is reliant upon or derived from, an underlying asset or group of assets (e.g. bonds, commodities, stocks)
Equity
In a company, it is the value of assets owned by the shareholders
Financial market
Any convenient set of arrangements where buyers and sellers can buy or trade a range of services or assets that are fundamentally monetary in nature
Investment banks
Banks that engage in a variety of activities in different financial markets
Money market
Financial markets that provide short-term borrowing and lending, usually defined as up to one year
Retail banks
Banks that provide services to individuals
Lender of last resort
Occurs when financial institution can obtain money from, usually, the central bank to balance their accounts when they are unable to do this from the financial markets in which they operate
Shadow banking
Parts of the financial market that are either much less regulated than the norm or are completely unregulated
Why are financial markets prone to regular crises that cause significant damage to the real economy?
Combination of speculation and genuine services
What roles do financial services play?
1) Saving
2) Lending
3) Facilitating the exchange of goods and services (e.g. mint coins, credit cards, process cheques)
4) Providing forward markets
5) Providing a market for equities (important way in which companies can finance their expansion)
6) Provide insurance
What are the different types of financial markets?
1) Money markets
2) Capital markets
3) Foreign exchange markets
4) Commodity markets (e.g. London Metal Exchange)
5) Derivatives markets
6) Insurance markets
What are the advantages for firms during a recession?
1) Lower wage inflation
2) Larger pool of available workers
3) Higher demand for inferior goods
4) Higher domestic demand if currency depreciates
What are the disadvantages for firms during a recession?
1) Lower demand, especially for luxury goods
2) Negative equity as land and property prices decline
3) Possible bankruptcy
What are the advantages for households during a recession?
1) Lower borrowing costs and mortgage repayments
2) Lower income tax rates if government uses fiscal policy to stimulate the economy
3) Cheaper goods and services as firms compete more aggressively for business
What are the disadvantages for households during a recession?
1) Falling real income levels
2) More expensive imports due to weaker currency
3) Threats of unemployment and resulting poverty and hardship
