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A-Level Economics Year 1 > Macroeconomics: How the macro economy works > Flashcards

Macroeconomics: How the macro economy works Flashcards

1
Q

How is the flow of new output measured?

A

The income approach
The output approach
The expenditure approach

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2
Q

How are national income, national output and national expenditure linked?

A

National income=National output=National expenditure identity

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3
Q

What is national income?

A

Flow of new output produced by the economy in a particular year, measured by the flow of factor incomes.

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4
Q

What are the key parts of the circular flow?

A

Households receive income through wages and salaries from their jobs and investments to buy goods and services that firms supply.

Businesses hire land, labour, and capital inputs when making products for which they pay wages and rent.
Firms receive payments from consumers which creates revenues and profits.

Government collects taxes to fund spending on public services.

External sector- UK buys imports from other countries, overseas businesses and consumers buy UK products.

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5
Q

What is the difference between injections and withdrawals?

A

Injections are spending entering the circular flow of income as a result of investment, government spending, and exports while withdrawals are spending that does not flow back from households/firms and is a result of saving, taxation, and imports.

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6
Q

What is the equation of equilibrium and national income?

A

national income= consumption + Investment + Government spending (Exports-Imports)
Y=C+I+G (X-M)
Actual injections=Actual withdrawals
I+G+X=S+T+M

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7
Q

What is the difference between real and nominal GDP?

A

Real GDP is the value of GDP adjusted for inflation while nominal GDP is the value of GDP without being adjusted for inflation.

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8
Q

What is GNP?

A

The market value of all products produced in an annum by the labour and property supplied by the citizens of one country.

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9
Q

What is GNI?

A

Total monetary value of all income earned by a country’s residents from both domestic and foreign sources.

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10
Q

What does GDP per capita measure?

A

The average economic output per person in a country.

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11
Q

What is aggregate demand?

A

The total demand in the economy and measures spending on goods and services by consumers, firms, the government and overseas consumers and firms.

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12
Q

What effects causes the AD curve to slope downwards?

A

Real income effect
Balance of trade effect
Interest rate effect

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13
Q

Why may the AD curve shift rightwards?

A

Consumers and firms have higher confidence levels leading to them investing and spending more because they will get a higher return.

If interest rates are lowered, it would be cheaper to borrow and reduce the incentive to save therefore increasing spending and investment.

Lower taxes mean that consumers have more disposable income resulting in AD rising.

Increase in government spending

Depreciation in currency means that M is more expensive and X is cheaper so AD increases.

Wealth effect

If credit is more available, spending and investment might increase.

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14
Q

What is the wealth effect?

A

A rise in the price of houses makes people feel wealthier so they are more likely to spend more.

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15
Q

What is aggregate supply?

A

Total output of goods and services that firms in an economy are willing and able to supply at a given price level.

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16
Q

Why is the AS curve upward sloping?

A

At a higher price level, producers are willing to supply more because they can earn more profits.

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17
Q

What does the short-run aggregate supply curve show?

A

Only covers the period immediately after a change in price level.

Shows the planned output of an economy when price changes, whilst the cost of production and productivity of the factor inputs remain constant e.g. wage rates.

Upward sloping because supply is assumed to be responsive to a change in AD which is reflected in the price level.

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18
Q

Why may the SRAS curve shift?

A

When there are changes in the conditions of supply:
Cost of employment might change e.g. wages
Cost of other inputs e.g. raw materials
Government regulation/intervention e.g. environmental laws
Labour productivity
Supply shocks
Unit wage costs perhaps arising from a higher minimum wage

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19
Q

What does long-run aggregate supply show?

A

Shows the potential supply of an economy in the long run
=prices+costs and productivity of factor inputs can change

Show the economy’s productive potential

Vertical because supply is assumed not to change as the price level changes.

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20
Q

What is macroeconomic equilibrium?

A

Rate of withdrawals= rate of injections
AD=AS
At a price above equilibrium, there is excess supply.
At a price below equilibrium, there is excess aggregate demand in the short run.

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21
Q

Why may there be a shift in the AS curve?

A

If the economy becomes more productive/increase in efficiency, supply will shift to the right which lowers average price level and increases national output.

If AS shifts inwards, price increases and national output decreases.

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22
Q

Why may there be a shift in the AD curve?

A

If firms have less confidence/ recession, AD may shift inwards causing the price level to fall and nation income to fall.

If AD increases, price and national output increase.

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23
Q

What are the factors which influence the level of economic activity?

A

Employment (influences production and consumption)
Confidence (influences level of spending and investment)
Events (natural disasters/ holidays influence the level of consumer spending)
Taxes and interest rates (influence how much firms and consumers borrow, save, or spend)

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24
Q

What is the multiplier process?

A

Occurs when there is new demand in an economy.
This leads to an injection of more income into the circular flow.
Leads to economic growth
More jobs, higher average incomes, more spending
More income is created.

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25
Q

What is the multiplier ratio?

A

Rise national income : Initial rise in AD
The number of times a rise in national income is larger than the rise in the initial injection of AD, leading to a rise in national income.

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26
Q

What would occur if an economy has a lot of spare capacity?

A

Extra output can be produced quickly and at little extra cost.
Makes SRAS elastic and means the size of the multiplier will be larger.

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27
Q

What does a small increase in AD lead to?

A

Large increase in national income

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28
Q

What happens if SRAS is inelastic?

A

Multiplier effect is likely to be smaller than its potential because if AD increases, prices will increase.

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29
Q

What is the “reverse” multiplier?

A

There is a withdrawal of income which leads to a larger decrease in income for the economy. This leads to a decrease in economic growth.

30
Q

What is marginal propensity to consume (MPC) ?

A

How much a consumer changes their spending following a change in income.
The higher the MPC, the bigger the size of the multiplier.

31
Q

How could the government influence MPC?

A

Changing the rate of direct tax
e.g. If consumers have more disposable income due to lower income tax rates, their propensity to consume might increase.

32
Q

What happens if consumers save more than they spend?

A

Size of the multiplier will be small.

33
Q

How can the multiplier be calculated?

A

1/ (1-MPC)

34
Q

What are examples of capital investment?

A

Robotics
Integrated plant
Machine tools
Infrastructure
Software
Logistics

35
Q

What is investment spending?

A

Purchase of capital/ the addition to the economy’s capital stock e.g. factories, machines

36
Q

What is the difference between savings and capital investment?

A

Savings represent the total amount of income that is not consumed by households, businesses, or the government. On the other hand, capital investment is spending on machinery, equipment, factories, technology, and infrastructure to create new capital goods.

37
Q

What is gross investment?

A

The total amount that the economy spends on new capital.
Includes an estimate for the value of capital depreciation

38
Q

How is net investment calculated?

A

Gross investment - capital depreciation

39
Q

What happens when gross investment is higher than depreciation?

A

Net investment will be positive meaning that businesses will have a higher productive capacity and can meet rising demand in the future.

40
Q

What is the difference between planned investment and actual investment?

A

Planned investment is the amount of investment firms plan to undertake during a year while actual investment is the amount of investment actually undertaken during a year.

41
Q

What are the factors influencing business investment?

A

Actual and expected demand for goods and services
Expected profits and business taxes
Interest rates and availability of business finance
Business confidence i.e. animal spirits

42
Q

What is the accelerator effect?

A

Investment levels are related to the rate of change of GDP. Thus an increase in the rate of economic growth will cause a correspondingly larger increase in the level of investment.

43
Q

How is a positive accelerator effect caused?

A

When demand is rising quickly
Firms respond initially by using their existing capacity more intensively/ running down stocks of finished products
If they expect high demand - increase spending on machinery and plant, factories and new technology to increase their supply capacity
Causes a positive accelerator effect- a rise in demand for consumer goods and services will cause a bigger % change in demand for capital goods.

44
Q

What are examples of the basic accelerator effect?

A

Investment is surging to create extra capacity for businesses selling cloud computing storage.
Investment in 5G mobile broadband networks to meet rising household and business demand.

45
Q

What is the concept of “animal spirits” by John Maynard Keynes?

A

The tendency for investment prices to rise and fall based on human emotion rather than intrinsic value.
When confidence is low, individuals save more, businesses save more too and because demand and profits are lower than expected, they cut back on production and postpone/ cancel capital investment projects.

46
Q

Why is investment important for the economy?

A

Injection of demand for capital good industries
Lift productivity/incomes
Economies of scale and better competitiveness
Helps to sustain export-led growth

47
Q

What are the limitations of the accelerator effect?

A

Time lags in investment - once a project is started, a firm will tend to want to complete it - even if demand slows down.
Firms won’t respond to every minor change in demand and output as investment requires planning and once started, can’t be easily stopped.

48
Q

What are the factors that affect consumer spending?

A

Real disposable income (i.e. income adjusted for inflation and after direct taxes and benefits)
Employment and job security
Household wealth
Expectations and sentiment- link to animal spirits
Interest rates- affect both the incentive to save and the cost of borrowing

49
Q

What is the difference between income and wealth?

A

Income is the “flow” and comes from providing factors of production.
Wealth is the “stock” of assets.

50
Q

What is the definition of debt?

A

Borrowing money from an outside source with the promise of paying back the loan, plus interest, at a later date.

51
Q

What are the key factors affecting household saving?

A

Real interest rates
Price expectations
Availability credit
Unemployment/job security
Consumer confidence/expectations
Taxation of savings
Trust in savings institutions

52
Q

Why is saving important?

A

Business survival- when there is a recession
Funding investment- pension funds, commercial banks need saving deposits from which they can lend to borrowers.

53
Q

What is a budget deficit?

A

Government spending exceeds tax revenue earned; this means that the government must have borrowed in order to finance its spending.

54
Q

What is a budget surplus?

A

Government spending is less than tax revenue earned; the government can pay back some of its debts.

55
Q

What is a balanced budget?

A

Government spending = tax revenue

56
Q

What is a cyclical budget deficit?

A

Gov spending is greater than tax revenue because the economy is in recession.

57
Q

What is a structural budget deficit?

A

Gov spending is greater than tax revenue but not related to the economic cycle.

58
Q

When GDP is rising why does the government automatically receive more tax revenue?

A

More revenue from income tax
More revenue from corporation tax (business profits increase)
More revenue from VAT/Sales taxes
More revenue from capital gains taxes ( rising GDP - people buy more assets- rise in the value of assets)

59
Q

Why may the government spend less?

A

Fewer people out of work - less spending on unemployment benefits
Working households may see pay increases - less spending on other benefits.
Some people will pay for private healthcare/education- less spending is needed on the NHS/schools.
Crime levels tend to be low when the economy is growing- less spending on the police.

60
Q

What are exports?

A

Goods and services sold from one country to another.

61
Q

What are the factors affecting demand for exports?

A

Real income
Relative prices of exports in world markets
The exchange rate
Non-price demand factors e.g. design and branding, quality
Strength of AD in key export markets
Level of protectionism - e.g. use of tariffs, quotas, and other trade restrictions.

62
Q

What is a trade surplus?

A

Value of exports is greater than the value of imports - AD will increase.

63
Q

What is a trade deficit?

A

Value of imports is greater than the value of exports - AD will fall.

64
Q

What causes an expansion in SRAS?

A

A rise in the general price level as producers respond to higher demand and prices.

65
Q

What causes a contraction in SRAS?

A

A fall in the general price level as producers cut back production if demand and prices are falling.

66
Q

What is the Keynesian aggregate supply curve?

A

Non-linear where the elasticity of aggregate supply is dependent in part on the level of spare productive capacity at different stages of a nation’s economic cycle.

67
Q

What does the Keynesian aggregate supply curve show?

A

1) Perfectly elastic portion of AS curve
2) Elasticity of AS now starting to drop as economy heads towards productive capacity
3) Diminishing returns might be setting in and the amount of spare capacity is falling
4) Elasticity of supply =0 when full capacity is reached.

68
Q

What might cause an inward shift of the Keynesian AS curve?

A

A rise in unit labour costs
Increases in the costs of imported energy
Higher environmental taxes

69
Q

What might cause an outward shift of the Keynesian AS curve?

A

A fall in world energy prices
Stronger exchange rate leading to lower import prices
Government subsidies to producers

70
Q

What is the difference between the classical and Keynesian views?

A

Classical economists believe in supply and demand. They think that any government intervention causes inflation. Therefore, the markets should be free because increased AD causes inflation. Keynesian economists believe in government intervention. At the lower levels of output, AS=elastic and so shift AD by C+1+G+X. Using up spare capacity to achieve economic growth.

71
Q

How can the multiplier effect be evaluated?

A

Depends on the MPC- not everyone is going to spend, they may save instead (higher income earners).
Who is more likely to save and spend?
Depends on what tax is cut- bottom or richest in society.
More likely to spend on imports which is a leakage- bad for the economy as money is leaving the economy. (it depends what they are spending their money on).
It depends on how much spare capacity is used. (Keynesian AS-AD curve). If the economy has high unemployment, it will impact more if close to full capacity, cost-push inflation.
May not be effective in the short run (takes time for people’s behaviour to change).
It depends on the magnitude of the tax cut, how much extra income.

72
Q

Why is the value of MPC important?

A

When the government is considering cutting direct taxes.
Cutting income tax stimulates consumption to help drive economic recovery after a recession.
The impact depends on MPC- if it is high, most of the extra disposable income will be spent.
If consumers save then it is ineffective.

A-Level Economics Year 1 (12 decks)

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