Macroeconomics pack 2 Flashcards
National income
The total value a country’s final output of all new goods and services produced in one year
Gross Domestic Product (GDP)
The value of of all goods and services produced in an economy over a year. GDP is the most common measure of national income
What are the three main methods for calculating national income
- Expenditure method: This adds up all the annual expenditure of consumers, investors, government spending and net exports
- Output method: The total money value of goods and services produced by the different sectors of the economy in a given year
- Income method: The total money value of factor payments (wages, rent, interest) fir the use of factors of production over the years
As there are so many calculations to make for the GDP of an economy, not all methods will be identical due to statistical errors, so an average of thee three methods is taken
Nominal GDP
the value of all goods and services in an economy over a year, unadjusted for inflation
Real GDP
the value of all goods and services in an economy over a year, adjusted for inflation
GDP per capita
The money value of all goods and services in an economy over a year divided by the total population of the economy. (gdp per person kind of)
GDP per capita formula
GDP per capita = GDP divided by population
Difference between GDP and GNI (Gross national income)
GNI is the value of all goods and services produced in an economy over a year within national borders, plus net income from production abroad, whereas GDP does not calculate the income from production abroad. GNI is a net figure
When will GDP be greater than GNI
When a country is sending significant profit, dividends and incomes to another country, so the net GNI figure becomes negative
When will GNI be greater than GDP
When a country is receiving significant dividends, profit and incomes from another country, so the net GNI figure becomes positive
Economic growth
The increase in real GDP over time
When comparing economic growth figures over time and between countries why do economists need to be careful
- Economic growth is the rate of change of real GDP eg. when economic growth is slowing down GDP will still be rising just at a slower pace
- Economic growth rate will disguise the level of GDP in a country eg. although there may be faster rates of growth in developing countries, this does not indicate that there GDP is higher overall
- The accuracy of growth figures depends on the validity of GDP statistics
Difference between actual growth and potential growth
Actual growth is a increase in real GDP in the economy over time whereas potential growth is an increase in the productive potential of the economy over time - Potential growth is the long-term growth rate of the economy
How can actual vs potential growth be shown on a PPF diagram
A movement in the PPF represents actual as output has risen but the productive potential has remained constant. In contrast, a shift from PPF1 to PPF2 represents potential growth as there has been an increase in the productive potential of the economy
Factors that cause actual growth
- An increase in business investment
- Reduction in savings
- Increase in consumption
- A decrease in the trade deficit
Factors that cause potential growth
- Investment in capital goods
- Advancements in technology
- Improvements in education and healthcare
Output gap
The differences between actual level of GDP and the productive potential of the economy
Positive output gap
When the actual level of GDP is above the productive potential of the economy. This can be achieved in the short run by operating over capacity
Negative output gap
When the actual level of GDP is below the productive potential of the economy. Associated with high amounts of spare capacity and high levels of unemployment
Why is difficult to get a precise value of the output gap
As it involves estimating the productive potential which is harder to measure
Business cycle (Trade cycle)
A phenomenon whereby GDP fluctuates around its underlying trend, following a regular pattern
Boom and slumps
Where the economy is operating well above its productive potential. This is followed by a slowdown where growth decelerates and then a recession if there are 2 consecutive quarters of negative growth. A prolonged recession would be a slump of depression
Features of an economic boom
- High rates of economic growth
- Low rates of unemployment and higher real wages
- Low levels of spare capacity
- High rates of inflation
Features of a recession
- Negative rates of economic growth
- High rates of unemployment and lower real wages
- High levels of spare capacity
- Low rates of inflation
Positive effects of economic growth on consumers
- Higher employment opportunities and income as businesses are likely to expand and therefore need to take on more labour. This will reduce unemployment, create more job opportunities and lead to higher incomes
- Higher consumer confidence as they are less worried about losing their jobs. This could lead to a reduction in saving and higher spending
Negative effects of economic growth on consumers
- Higher inflation means that incomes consumers earn will be lower in real terms. For example, in the UK low or falling real incomes have been a major issue in recent years
- Higher relative poverty and income inequality as the gains from economic growth may be more beneficial for those on higher incomes than those on lower incomes. Eg. top business owners could see incomes rise substantially more than shop floor workers.
Positive effects of economic growth on firms
- As there are more people being employed demand for goods and services increase so they will be making higher sales and profits eg. a high end restaurants may serve more customers as consumers use their higher income to spend on more meals out
- There will also be an increase in their economic confidence and will therefore have more incentive to reinvest their profits in order to expand via higher investment.
Negative effects of economic growth on firms
- Rising costs as inflation and wages rise if there is an increase in cost push inflation. Therefore manufacturers are likely to see total cost rise and therefore it is uncertain if profits will rise
- Reduced international competitiveness as UK firms may need to increase their prices so UK exports are less competitive in international markets, with negative effects on the UK’s trade deficit and profitability of firms
Positive effects of economic growth on the government
- Higher tax revenue as workers earn higher incomes, they will pay more income tax to the government as well as more VAT on foods and services purchased
- Reduced need for government spending as there is less need for the government to spend on welfare such as the job seekers allowance, also less need for expansionary policy
Negative effects of economic growth on the government
- Conflict with other macroeconomic objectives such as low inflation, reduced environmental damage and a reduced trade deficit
Positive effects of economic growth on current and future living standards
- Current living standards may rise as higher employment and incomes allows consumers to increase spending on goods and services
- Future living standards may rise if economic growth is fuelled by higher productivity, such as new technology in the economy. This should boost the productive potential in the future
Negative effects of economic growth on current and future living standards
- May cause current living standards to fall: Opportunity costs, as higher consumer goods may need to be sacrificed in order to increase the production of capital goods. Can be shown on the PPF
- May cause future living standards to fall as fast and unsustainable economic growth could damage the environment due to increased production and transportation of goods around the world
Factors that create desirable economic growth
- The magnitude of growth: should be around 2-3% so inflation doesn’t get too high
- Use of renewable energy makes economic growth more sustainable
- An increase in potential growth, such as via education and new technology, is more sustainable and os less likely to cause inflationary pressure
Subjective Happiness
Feelings of wellness and satisfaction that cannot be objectively measured
What does economic growth suggest the relationship between happiness and economic growth
Economic theory suggests that rising real incomes will lead to an increase in living standards and therefore happiness as consumers can purchase more goods and services to fulfill their needs and wants
The Easterlin Paradox
Highlights an apparent contradiction and finds that happiness and income are positively correlated at low levels of income however once consumers have met their basic needs, consumption of more goods and services is less important than other non-financial factors
Importance of relative incomes
We only feel happier if we feel better off then the people with whom we compare ourselves. This helps to explain why rising incomes may not be causing higher happiness, as incomes may have risen for all members of society
UK national wellbeing
National wellbeing is an economic measure of quality of life conducted by the ONS in the UK that attempts to look beyond simply the UK’s GDP figures, such as including health, the environment and personal well-being
Limitations of measuring National Well-being statistics
- Harder to measure subjective indicators accurately as they are based on feelings or opinions
- The measure is not aggregated meaning that there is no single measure of well-being from the measure
Inflation
An increase in the general price level
Disinflation
An fall in the rate of inflation
Deflation
A fall in the general price level
What does having a stable rate of inflation provide
A stable rate of inflation provides a more certain business environment to allow investment and growth
When does good deflation occur
When aggregate supply is increasing (eg. due to lower oil prices or higher productivity) This should be good for the economy as there is growth in the economy and a more internationally competitive export sector
When does bad deflation occur
When aggregate demand is falling which is associated with falling growth and rising unemployment
2 main measures of inflation
- Retail Price Index (RPI) and related measures
- Consumer Price Index (CPI)
RPI
Traditional measure of the price level and is used to index state pensions and benefits
RPI itself is the headline rate of inflation
RPIX is the RPI excluding mortgage repayments so that policymakers can see changes in the price level without including volatile and distorting elements of the RPI
RPIY is the RPI excluding mortgage repayments and indirect taxation to allow policy makers to see how prices are changing in the wider economy
CPI
It is the EU measure and therefore allows comparisons to be made between EU countries
Differences between CPI and RPI
- CPI excludes a number of items RPI includes mainly relating to housing costs eg. council tax, mortgage interest payments, house deprecation and housing fees
- CPI is a geometric mean whereas RPI is arithmetic, making CPI generally lower than the RPI figure just due to this statistical difference
When will CPI be lower than RPI
In times of a housing boom the CPI will be lower than RPI as housing costs rise at a faster rate than other items
When will the RPI be lower than the CPI
With very low interest rates, mortgages repayments and housing costs, the RPI figure will be much lower than the CPI figure such as in 2009
How is the rate of CPI inflation calculated
How much on average a representative basket of goods and services costs in the UK
1. Price surveys are needed to find out much goods and services have cost in each shop
2. The annual family expenditure survey allows us to see how much households are spending on each good or service
3. All this information is then used to construct a weighted price index.
Limitations of using CPI to measure inflation
- Inflation is only an average figure - ones personal rate of inflation may be higher or lower than this
- The weightings are fixed each year and therefore may not be accurate during the entire year
- The weightings of goods this year is different to previous years, which affects the ability to compare prices across time periods
How to calculate inflation using a weighted index
calculate index number by adding percentage change to 100
Multiply index number by he percentage weight given
Inflation can be calculated as a percentage change in the two final weighted price indices
Demand pull inflation
An increase in the general price level, specifically caused by higher AD in the economy
Cost-push inflation
An increase in the general price level, specifically caused by higher costs of production
When does cost-push inflation occur
- Higher commodity prices
- Higher unit labour costs
- Increases in indirect taxation
- A fall in the exchange rate
Money supply
The total amount of money in circulation or in existence in a country
What happens to costs for firms if the price level rises
There is a risk of a wage-price spiral. As inflation is higher due to a higher money supply, workers need to bargain their wages higher too. This then leads to cost-push inflation, as wages are a cost of production. This then leads to businesses raising prices and so the process can continue
Effects of inflation on consumers
- Redistribution of income: as high inflation will reduce the real value of incomes, savings and debt therefore inflation will: benefit borrowers: as the value of the best they owe has reduced in real terms
- Hurt savers as the value of their savings decrease
- Hurt those on fixed incomes as the value of their incomes have fallen and they cannot negotiate wages to follow inflation
Effects of inflation on firms
- Reduced confidence and investment: as inflation is no longer low and stable. Therefore there is greater uncertainty for businesses which could reduce investment as they are unsure where their expansion plans will be profitable
- Reduced international competitiveness: rising UK inflation relative to other countries could mean the UK exports are more expensive on international markets
- Demand pull inflation indicates higher profits for firms as consumers demand is high
- Cost push inflation indicates lower profits as costs are higher
Effects of inflation on workers
- Rising inflation reduces the real value of incomes earned by workers
- Employment prospects - Demand pull inflation indicates better job prospects as consumer demand is high and therefore businesses may be more willing to expand employment and wages
- Cost push inflation: indicates lower profits as costs for firms increase so they may consider wage freezes and redundancies to offset rising costs
Effects of inflation on government
- A rising in inflation will have an effect on other macroeconomic objectives:
- economic growth may be low as there is a lack of consumer confidence but in times of demand pull inflation AD is high so economic growth may be high
- Unemployment: there is generally a trade off between unemployment and inflation. Demand pull inflation could improve employment prospects
- Balance of payments: rising inflation can lead to a lack of international competitiveness of UK businesses and therefore could reduce exports ad widen the UK’s trade deficit
Employment
The total number of people with a job (working for firms or other organisations or are self employed)
Unemployment
People who are without a job but who are able and willing to work at current wage rates (i.e economically active)
Economically inactive
Those people of working age who are not looking for work, for a variety of reasons (such as students, those who have retired and the disabled)
When does employment rise
If more people are gaining jobs then losing jobs then employment rises and unemployment falls
When does unemployment rise
If more people are losing jobs than gaining jobs employment falls and unemployment rises
how to calculate rate of employment, unemployment and economic inactivity
rate of .. = numbers employed, unemployed or economically inactive
divided by population of working age (or Uk workforce for unemployed)
times 100
