Everything (- econometrics) Flashcards
Microeconomics, macroeconomics, public economics, international economics & economic growth (284 cards)
1
Q
What is demand?
A
The quantity of a good or a service that a consumer is willing and able to purchase at any given price level
2
Q
What is supply?
A
Supply is the quantity of a good or service that a producers is will and able to sell at any given price level
3
Q
What is the equilibrium price?
A
The intersection of supply and demand - the price at which quantity demanded is equal to the quantity supplied
4
Q
What does the assumption that consumers/producers are price takers mean?
A
No single consumer/producer can influence the market price, hence they can only chose the quantity and take the price as given
5
Q
What is consumer surplus?
A
Difference between the price consumers are willing to pay and the price they actually pay
6
Q
What is producer surplus
A
Difference between the price sellers are willing to sell for and the price they actually receive
7
Q
What is own price elasticity and how can it be estimated?
A
Own price elasticity measures the demand response of a good to a change in its price
change in quantity demanded / change in price
8
Q
What does an own price elasticity of demand smaller than 1 suggest?
A
Inelastic demand e.g., necessities
9
Q
What does an own price elasticity of demand greater than 1 suggest?
A
Elastic demand e.g., luxury goods
10
Q
What is the cross price elasticity of demand and how is it estimated?
A
Cross price elasticity measures the responsiveness of the quantity demanded of one good (x) to the change in price of another good (y)
change in quantity demanded of good x / change in price of good y
11
Q
If the cross price elasticity of a good is positive what type of goods are they?
A
substitutes
12
Q
If the cross price elasticity of a good is negative what type of goods are they?
A
complements
13
Q
What is income elasticity of demand and how is it estimated?
A
Income elasticity of demand measures the responsiveness of quantity demanded to a change in income
change in quantity demanded / change in income
14
Q
What does it suggest if the income elasticity of a good is greater than zero?
A
it is a normal good
15
Q
What does it suggest if the income elasticity of a good is greater than one?
A
it is a luxury good
16
Q
What does it suggest if the income elasticity of a good is less than zero?
A
it is an inferior good
17
Q
What causes a shift in the demand curve?
A
Factors that change the quantity demanded at a given price e.g., change in tastes, population, income, prices of substitutes of complement goods and expectations of future prices
18
Q
What causes a movement along the demand curve?
A
A change in the price of the good or service
19
Q
What is the budget constraint?
A
All possible consumption bundles the consumer can afford with their income (usually focused on two goods)
20
Q
What causes a pivot in the budget constraint?
A
Price of one good changes, while the other holds
21
Q
What causes a shift in the budget constraint?
A
Change in income
22
Q
What is a consumption bundle?
A
A combination of different quantities of the various goods a consumer wants to consume
23
Q
What is utility?
A
The satisfaction that a consumer derives from consuming a particular consumption bundle
24
Q
What assumptions does consumer demand theory make about utility?
A
Completeness - bundles can be ranked in terms of their utility
Transitivity - the utility ranking of bundles is internally consistent
Preference for more over less
25
What is 'diminishing marginal rate of substitution'
In order to hold utility constant, diminishing quantities of a good or service need to be sacrificed so as to obtain successive equal increases in the quantity of another good
26
What is the budget constraint line?
A line showing all possible consumption bundles which are affordable and exploit all the resources available to the consumer
27
What does the non-satiation assumption about taste imply?
Consumers will chose a point on the budget constraint and certain points will be preferred to others
28
What is an indifference curve?
A line that shows combinations of two goods that give a consumer the same level of satisfaction
29
What concept measures the slope of the indifference curve?
Marginal rate of substitution
30
What is the income effect?
the change in consumption that happens when a person's income changes
31
What is the substitution effect?
the change in demand for a product when its price increases relative to other products
32
What is absolute advantage?
When one firm can produce a given quantity of a good with fewer inputs compared to another firm
33
What is comparative advantage?
When one firm can produce a good at a lower opportunity cost compared to another firm
34
How is overall output maximised according to comparative advantage?
Specialising to achieve comparative advantage and then trading
35
What is an isoquant?
A line showing all possible combinations of inputs that can produce a given efficient level of output
36
What is the isocost line?
A line showing different input combinations with the same total cost
37
What do we assume about how firms make production choices?
Firms wish to minimise the cost of producing their given level of output
Firms will produce an output where marginal cost equals marginal revenue
38
What is the marginal rate of technical substitution in production?
the rate at which one input can be replaced with another while keeping the same level of output
39
What is constant returns to scale?
When an equal proportionate increase in all inputs gives the same proportionate increase in output
40
What is decreasing returns to scale?
When an equal proportionate increase in all inputs gives a smaller proportionate increase in output
41
What is increasing returns to scale?
When an equal proportionate increase in all inputs gives a larger proportionate increase in output
42
What is short run marginal cost?
The increase in short run total cost if output increases by one unit
43
What is long run marginal cost?
The increase in long run total cost if the output increases permanently by one unit
44
Where does the marginal cost curve intersect the average cost curve?
at the minimum point
45
Assumptions of perfect competition (6)
Firms produce homogenous products
Firms are price takers
No barriers to entry or exit
Average cost curves eventually end up sloping upwards
Perfect information between buyers and sellers
Firms maximise profits
46
What level of output do firms choose in perfect competition?
Where marginal cost equals marginal revenue, under perfect competition the marginal revenue is always equal to the price
47
Under perfect competition, how should firms respond when marginal cost is less than marginal revenue?
increase output to increase profits
48
Under perfect competition, how should firms respond when marginal cost is greater than marginal revenue
reduce output to increase profits
49
Characteristics of a monopoly (4)
One firm supplies the whole market
Significant barriers to entry
Firm is price maker
No close substitutes
50
How do price and output differ between perfect competition and monopoly market structures?
Price is higher and output is lower under a monopoly
51
Characteristics of monopolistic competition (3)
Many firms
Free entry and exit
Differentiated product but high degree of substitutability
52
Characteristics of an oligopoly (4)
Market power held by a few firms
High barriers to entry
Product differentiation
Interdependence of firms
53
What is a 'Game' in the context of game theory?
A situation in which decisions by rational agents are necessarily interdependent
54
What is a 'Strategy' in the context of game theory?
A detailed game plan describing how the agent will act or move in every conceivable situation
55
What is a 'Dominant Strategy' in the context of game theory?
Where an agent's best strategy is independent of those chosen by others
56
What is the Prisoners' Dilemma?
A paradox that shows how two rational people making decisions in their own self-interest can lead to a worse outcome for both - highlighting the incentive for collusion
57
What is a cartel?
An agreement between a group of producers to control supply or manipulate prices
58
Why are cartels unstable?
It is the dominant strategy for all firms involved to cheat the agreement by reducing their price and then increasing their market share
59
What is a Bertrand competition
Where firms, in an oligopolistic market, compete by setting prices for identical products
60
Key features of Bertrand competition (4)
Firms compete on price
Homogeneous products
Simultaneous decision making
No capacity constraints - firms can meet demand
61
What is the Bertrand paradox?
In a duopoly, the Bertrand model predicts that both firms will continue to undercut each other until price equals marginal cost resulting in zero economic profit
62
What is Cournot competition?
Where firms, in an oligopolistic market, compete by setting quantities not prices
63
Key features of Cournot competition (5)
Products are homogenous
Simultaneous decision making
Price determined by market demand
Results in positive profits and price above marginal cost
Less competitive than Bertrand
64
What is Stackelberg competition?
A sequential quantity-setting model, in an oligopolistic market with a leader-follower dynamic
65
Key features of Stackelberg competition (4)
leader moves first and sets quantity
Follower observes and responds optimally
Leader has first mover advantage and earns higher profit
Assumes homogenous product and quantity competition
66
Example of perfect competition
Agricultural markets
67
Example of monopolistic competition
Soft drinks industry
68
Example of an oligopoly
Airlines
69
Example of a natural monopoly
Public utilities
70
Example of a monopoly
Amazon
71
What is the Chain Store Paradox?
A game theory paradox where a large firm, with multiple stores, faces new competitors in different markets (e.g., towns) - they should theoretically accommodate each entrant to maximize long-term profits, however they often engage in aggressive price competition to deter future entrants, even if it leads to short-term losses
72
Explain the chain store paradox
In each market, at the introduction of a competitor, the large incumbent can either fight (price war) or accommodate the new entrant
In theory, fighting is costly and could reduce long term profits as reducing prices in one store might have to be reciprocated across the other stores so therefore the firm should accommodate
But in reality, if firms fight early entrants they can deter future entry
The paradox highlights the conflict between short-term profit maximisation and long-term strategic considerations
73
Why is the supply curve upward sloping?
The law of supply says that as the price of a good or service increases, the quantity supplied will increase
74
Why is the demand curve downward sloping?
The law of demand says that as the price of a good or service decreases, the quantity demanded will increase
75
How does tax affect the supply curve?
Shifts it upwards
76
How does tax affect the demand curve?
Shifts it downwards
77
What is marginal utility?
The benefit derived from consuming an additional unit of a good or service
78
When are markets in equilibrium?
When the supply and demand curves are equal
79
What are economies of scale
Cost advantages realised through an increased level of production, as average cost per unit falls
80
What is a natural monopoly
A monopoly that occurs due to high barriers of entry, as one firm can supply a good or service more efficiently (with fewer inputs) than other firms
81
What is asymmetric information?
When one party has more information on the transaction than the other
82
How do firms demand labour?
labour is a derived demand which means that it depends on the demand for the firm's good or service
83
How do competitive firms determine their demand for labour
Firms will employ labour until the marginal revenue product of labour equals the wage rate
84
What is the marginal revenue product of labour (MRPL)?
the extra revenue obtained from one unit of labour - it is the product of marginal revenue and marginal product of labour
85
What is the shape of the MRPL curve?
downward sloping - determined by diminishing marginal returns to labour
86
What is the labour force?
all individuals in work or seeking employment
87
What is labour supply?
the number of hours people are willing and able to supply at a given wage rate
88
What does the backward bending labour supply curve mean?
after a certain point, higher wages can lead to a reduction in hours worked
89
What is the shape of the labour supply curve?
Upward sloping - as the wage increases people are incentivised to work more
90
How does a change in wages of one industry affect another?
labour is incentivised to move into the industry with higher wages which shifts the labour supply curve left in the other industry
91
What is a monopsony labour market?
When there is a single employer dominating the hiring of labour in a particular market - allowing them to better control the wage
92
What are the differences (in wages, employment & market power) between monopsony and competitive factor markets?
One firm dominates labour demand in monopsony whereas there are many firms demanded labour in a competitive market and therefore no single firm can influence wages
Key differences:
- Wages: monopsonists pay less than marginal revenue product, whilst competitive market pays where wage equals MRP
- Employment: monopsonists hire less labour than competitive markets
- Market power: Monopsonists have power in labour market, competitive firms do not
93
What is marginal revenue product (MRP)?
The extra revenue a firm earns from employing one more unit of a factor (e.g., labour)
94
What are policy responses to monopsony power? (4)
Minimum wage laws
Encouraging unions
Anti-trust action
Public provision
95
Example of a monopsony labour market
NHS
96
What does the Lorenz curve measure?
Inequality
97
What is the elasticity of labour supply in the short run?
Often inelastic as it is difficult for people to switch markets in the short-run
98
What does human capital theory suggest?
If the rate of return on human capital (investment into education) is greater than the rate of return on alternatives people will take up educational opportunities
99
What causes wage differentials in the labour market? (4)
skills
discrimination
job characteristics
trade unions
100
What does risk averse mean?
a reluctance to take risk
101
Why is there demand for insurance?
Most people are risk averse
102
Why is there supply for insurance?
Profits can be made through risk pooling and risk sharing
103
What is moral hazard?
When one participant has incentives to increase their exposure to risk because they do not bear the full costs associated with that risk
104
What is adverse selection?
When one participant does not know what the other participant is like (characteristics)
Asymmetric information results in a party taking advantage of undisclosed information to benefit more from a contract or trade
105
What is productive efficiency
an economy or entity can no longer produce additional amounts of a good without lowering the production level of another product
106
What is pareto efficiency?
when an allocation of resources cannot be changed without making somebody worse off
107
Criticism of pareto efficiency
it does not consider inequality
108
What is a market failure?
where there is an inefficient allocation of goods and services in a market
109
Causes of market failures (5)
public goods
externalities
imperfect competition
missing markets
imperfect information
110
What is a public good
a good that is non-rivalrous and non-exclusive
111
Why is there no incentive for the free market to provide public goods
Cannot charge people for it
112
What is an externality
where production or consumption directly impacts a third party which is not considered by the party producing or consuming
113
How does asymmetric information affect markets?
It distorts markets by creating unequal access to information between buyers and sellers which can lead to inefficient outcomes (e.g., moral hazard, adverse selection or market failure)
114
What is a negative externality?
Marginal social cost > Marginal private cost
(over-consumption/production)
115
Examples of a negative externality (3)
Pollution
Smoking
Congestion
116
What is a positive externality?
Marginal social benefit > marginal private benefit
(under-consumption/production)
117
Examples of a positive externality? (3)
Education
Vaccinations
Research and development
118
How can you address externalities?
Taxes (e.g., carbon tax)
Subsidies/Grants (e.g., R&D grants)
Regulations (e.g., emission limits)
119
What is Coase Theorem?
It states that if property rights are clearly defined and transaction costs are low, private negotiations will lead to efficient outcomes regardless of who holds the initial rights (and therefore no need for government intervention)
120
Assumptions of Coase Theorem (4)
Clearly defined property rights
Low or no transaction costs
Perfect information
Small number of parties (so negotiation is practical)
121
Example of Coase Theorm
Situation: a factory pollutes a river, harming fisherman downstream
- if the fisherman have the right to clean water, the factory must pay them to pollute
- if the factory has the right to pollute, fisherman can pay the factory to reduce pollution
Outcome: as long as the parties can bargain costlessly, the final level of pollution will be efficient
122
What is the population of working age?
All people aged between 15-64
123
Limitations of the Coase Theorem (4)
High transaction costs
Power imbalances
Poorly define property rights
Enforcement issues
124
What is employment rent
The difference between the value of employment and its opportunity cost (unemployment) - e.g., wages - unemployed benefit
125
What is the reservation wage?
The wage at which a person is indifferent from working or being unemployed
126
What is a stock?
A quantity measured at a point in time
127
What is a flow?
A quantity measured per unit of time
128
What are the functions of money (3)
Acceptability
Unit of account
Store of value
129
Types of money aggregates (4)
M0: Physical currency
M1: M0 + demand deposits
M2: M1 + savings deposits
M3: M2 + large term deposits and money market shares
130
How does money relate to the business cycle?
It is procyclical - growing when the economy is growing and falling when the economy is in recession
131
Other desirable characteristics of money (4)
fast and low cost transactions
privacy / auditability - transactions should generally be private but auditable by authorities
recourse / fidelity - fraudulent transactions should be reversible and money balances should reflect past transactions
accessibility - monetary services should be easily accessed by all
132
What does the budget constraint look like for an impatient consumer?
Will typically borrow, even if their expected future income is less than their current income
133
What are assets?
Everything owned by an entity and everything that is owed to that entity
134
What is consumption smoothing?
Where people borrow if income is lower than their expected future income and will save if their current income is higher than expected future income
135
What are liabilities?
Everything an entity owes to others
136
What is net worth?
Difference between assets and liabilities
137
Components of aggregate demand
Consumption
Investment
Government spending
Net exports
138
What does it mean if a bank is illiquid?
When it does not have enough reserves to meet demand for deposit withdrawals
139
What does it mean if a bank is insolvent?
When the value of its fixed liabilities exceed the value of its assets
140
What is quantitative easing?
non-traditional monetary policy tool used by central banks to stimulate the economy when interest rates are already near zero and can’t be cut further
it involves the central bank buying large amounts of government bonds or other financial assets to inject money into the economy
141
Objectives of quantitative easing (4)
stimulate economic growth
raise inflation
lower long term interest rates
encourage borrowing and investment
142
Risks of quantitative easing (4)
Asset bubbles - cheap money can inflate asset prices
Inequality - may benefit asset holders more than the general public
Currency depreciation
Future inflation
143
What is the bank rate?
the interest rates at which some banks can lend to or borrow from the Bank of England
144
Disadvantages of lending for banks
increase in illiquidity risk (fewer deposits)
increase in insolvency risk as loan assets are more risky than deposit assets
145
Incentive to loan for banks
loans may pay higher interest than deposits held at the bank of england
146
What does it mean for a bank to lend money?
they replace deposits held at the central bank with loan assets
147
What is monetary policy?
The use of interest rates, money supply and other tools by a central bank to influence inflation, employment and economic growth
148
What are the advantages of monetary policy? (5)
quick implementation
flexible and adjustable
controls inflation
stimulates growth
independent of politics
149
What are drawbacks of monetary policy? (5)
time lags
limited effectiveness in recessions
uneven impacts
risk of asset bubbles
liquidity traps
150
What is a liquidity trap?
Where interest rates are very low but fail to stimulate economic growth because because people prefer to hold cash
151
What is the objective of quantitative easing?
Increase money supply in the economy - boosting economic activity
152
What are the intermediate targets/transmission mechanisms of monetary policy? (9)
market interest rates
asset prices
expectations / confidence
exchange rate
import prices
net exports
aggregate demand
domestic inflationary pressure
153
What does a decrease in the bank rate mean for banks?
Increased loan assets
Decreased deposit liabilities
154
How does a decrease in the interest rate affect current and future consumption for a saver? (all income in current period)
Substitution effect - future consumption is relatively more costly to current consumption, encouraging saver to reduce future consumption and increase current consumption
Income effect - relatively less well off, cannot afford as much in each period, encouraging saving to reduce consumption in each period
Both effects encourage reduce consumption in future period but impact on current consumption is ambiguous
155
How does a decrease in the interest rate affect current and future consumption for a borrower? (all income comes in future period)
Substitution effect - current consumption is cheaper than future consumption hence increases current consumption relative to future consumption
Income effect - can afford more than before incentivising an increase in both current and future consumption
Both effects encourage higher consumption in the current period but the impact on future consumption is ambiguous
156
What is the main instrument of monetary policy?
The bank rate
157
What is the inflation rate?
The rate of growth of prices of goods and services in the economy
158
What is the main target of monetary policy?
Inflation rate
159
Advantages of inflation targeting (5)
price stability
transparency and accountability of central bank
anchors inflation expectations
disciplined monetary policy
improves central bank credibility
160
Drawbacks of inflation targeting (5)
ignores other economic objectives
not effective against supply shocks
reduced flexibility
potential conflict with fiscal policy
reliance on forecasts
161
What are intermediate targets of monetary policy?
The channels through which changes in the
policy interest rate affect inflation i.e., transmission mechanisms
162
What can affect the pass through of monetary policy?
market conditions
monopoly or monopsony power
regulation
163
What is the technical definition of a recession?
two consecutive quarters of falling GDP
164
Characteristics of a recession (9)
Decline in GDP
Rising unemployment
Reduced consumption & investment
Falling production
Reduced profits
Lower inflation or deflation
Tighter credit conditions
Stock market decline
General economic uncertainty
165
Approaches to measuring GDP (3)
Production approach - value of goods and services produced in the economy
Income approach - sum of all incomes
Expenditure approach - sum of aggregate demand
166
What is Okun's law
The negative relationship between output (GDP growth) and the unemployment rate
167
What is an alternative definition of a recession?
The level of output is below its normal level - the economy could still be growing but its producing less than its potential
168
What happens to unemployment when real output falls?
unemployment rises
169
What does Okun's coefficient tell us?
A number that represents the expected change in unemployment associated with a 1% increase in GDP
170
Limitations of GDP
It does not consider sustainability (e.g., environmental externalities)
Not a measure of wellbeing
Difficult to value services
Difficult to measure over time
171
What are the opportunity costs for firms of investment? (3)
Paying off outstanding debt
Purchase of financial securities
Paying dividends
172
What is real GDP?
nominal GDP adjusted to account for changes in the price of goods and services
173
Why is investment more volatile than income and consumption? (4)
There is no natural incentive to smooth investment and it can easily be postponed
Emergence of new technology
Coordination problems
Credit cycles
174
Why is consumption smooth?
Households use savings or borrow to smooth consumption against temporary falls in income
175
What are automatic stabalisers?
Government interventions which dampen fluctuations over the business cycle e.g., income tax, unemployment benefits and social insurance
176
Measures of inflation
CPI
CPIH
RPI
GDP deflator
177
What does the GDP deflator measure?
changes in prices of domestically produced goods
178
What is the GDP multiplier?
The proportionate change in GDP from a change in expenditure
179
How do transfers impact the fiscal multiplier?
some money will be saved and therefore not circulate into the economy - dampening the multiplier
180
Which components of government spending are smooth over the business cycle?
Health
Education
181
How does trade affect the fiscal multiplier?
Openness to trade reduces the effect of fiscal policy as more money will be spent on imports
182
Determinants of the fiscal multiplier (7)
The composition of spending
Economic Slack
Flexible prices and wages
Monetary policy response
Direct spending vs transfers
Trade
Taxes
183
How does tax affect the fiscal multiplier?
When tax rates are high, increases in gross income will only partially increase disposable income
184
What is the fiscal multiplier?
The proportionate change in GDP in response to fiscal policy
185
How does the composition of spending affect the fiscal multiplier?
Multipliers are higher when the new spending is a complement to rather than a substitute for households and firms spending
186
When is the government budget in deficit?
When government spending is greater than tax revenues
187
When is the government budget in surplus?
When government spending is less than revenues
188
How does international trade affect GDP?
A trade surplus increases GDP, a trade deficit decreases GDP, ceteris paribus
189
What is the current account?
The sum of net payments to and from the rest of the world (transactions of imports, exports, investment income, investment payments and transfers)
190
What is a current account surplus?
If net payments from the rest of the world are positive
191
What is a current account deficit?
If net payments from the rest of the world are negative
192
How can a country finance a current account deficit?
With a capital account surplus
193
What is the capital account?
Net capital flows - the difference between what foreigners invest in domestic assets and what domestic investors invest in foreign assets
194
What is a capital account surplus?
net capital inflows: foreigners are buying more domestic assets than domestic residents are buying foreign assets
195
What is a capital account deficit?
net capital outflows
196
What is the balance of payments?
A record of all economic transactions between residents of a country and the rest of the world over a specific period. It summarizes both inflows and outflows of money, essentially showing what a country owns abroad and what foreigners own in that country.
197
Components of the Balance of Payments
Current account
Capital Account
Errors and Omissions
198
Does the balance of payments balance?
In principle, yes; in practice, no
If a country runs a current account deficit, it must be financed by a capital account surplus - i.e., borrowing or selling assets to foreigners
199
What is the interest parity condition?
A no-arbitrage condition that links interest rate differentials between two countries to the expected changes in exchange rates. The idea is that investors shouldn't be able to earn profits by exploiting differences in interest rates and currency movements.
200
What does the interest parity condition say for domestic and foreign interest rates?
Unless countries are willing to tolerate large movements in their exchange rates, domestic and foreign exchange rates likely move together
201
How do interest rates affect investment?
negatively
202
What are the determinants of imports? (2)
domestic income (direct relationship)
real exchange rate (direct relationship)
203
What are the determinants of exports?
foreign income (direct relationship)
real exchange rate (inverse relationship)
204
What is the impossible trilemma?
It states that a country cannot simultaneously achieve all three of the following policy goals:
1) fixed exchange rate
2) free capital movement
3) independent monetary policy
205
Why is the impossible trilemma impossible?
Pursuing two of the goals forces a trade off and makes the third unattainable
206
What is the real exchange rate?
The product of the nominal exchange rate and the ratio of prices between the two countries. It is the purchasing power of a currency relative to another at current exchange rates and prices.
207
What is the nominal exchange rate?
the price of the domestic currency in terms of foreign currency
208
What is an appreciation of domestic currency?
The increase in the price of the domestic currency in terms of foreign currency (increase in the exchange rate)
209
What is a depreciation of domestic currency?
Decrease in the price of domestic currency in terms of foreign currency (decrease in the exchange rate)
210
How is the real exchange rate constructed?
By multiplying the nominal exchange rate by ratio of prices between the two countries: nominal exchange rate * (foreign prices/domestic prices)
211
How to interpret the real exchange rate?
How much of a foreign good you can buy in exchange for a domestic good, after adjusting for price levels in both countries
212
How do exchange rate markets work?
they are platform where currencies are bought and sold, primarily to facilitate international financial transactions, not just trade
213
What is the biggest influence on exchange rate markets?
Financial capital flows
Financial investors move large sums across borders, and these movements drive most currency demand and supply
214
What mechanisms make the current and capital account balance?
Exchange rate adjustments
Changes in interest rates
Capital flows
215
Assumptions of comparative advantage (9)
two countries & trade of two goods
one factor of production
constant opportunity costs
perfect competition
no transport costs
full employment of resources
labour mobility within countries but not between
technology is fixed and differs across countries
trade is balanced
216
What does the gravity model say about trade?
trade between two countries is directly proportional to the size of their economies and inversely proportional to the distance between them
217
What are does the gravity model imply about trade flows?
larger economies trade more, because they produce and consume more
closer countries trade more because of lower transportation and transaction costs
other factors like common language, trade agreements and colonial ties can also increase trade
218
What does the Heckscher-Ohlin theorem say about trade?
Countries will export goods that utilise their relatively abundant factors of production and import goods that require factors they have relative scarcity
219
Criticisms of comparative advantage (5)
Assumptions don't hold in reality (e.g., no transport costs / international labour immobility)
Doesn't consider diminishing returns/diseconomies of scale
Holds back the development of countries (especially those with low-value industries)
Income inequality between countries may worsen
Can cause an over reliance on natural resources
220
What is intra-industry trade?
Where a country imports and exports the same goods or goods in the same sector (e.g., cars)
221
What is autonomous consumption?
consumption regardless of income (i.e., minimum level of consumption to meet basic needs)
222
How does an increase in interest rates affect consumption (& investment)?
Higher interest rates dampen consumption, because:
(1) increases the cost of borrowing
(2) saving becomes more attractive so consumers defer spending
(3) reduced asset values leads to lower perceived wealth
(4) rising rates may signal tightening and lower confidence
223
How do interest rates affect government spending?
Typically unaffected in the short run
May influence long term borrowing costs and debt sustainability
224
How do interest rates affect net exports?
Higher interest rates appreciate the currency, making exports less competitive and increase import demand
225
How does an increase in interest rates affect overall aggregate demand?
Shifts inwards
226
Characteristics of an economic expansion (9)
Rising GDP
Increasing employment
Increased spending & investment
Increasing production
Rising profits
Moderate inflation
Easier credit availability
Stock market growth
Optimism and confidence
227
What is fiscal policy?
Use of government spending and taxation to influence economic activity
228
What is the government's role in macroeconomic stabalisation?
to stabilise output and employment through business cycles by using the budget balance
229
How does fiscal policy change in relation to the business cycle?
Counter cyclically - i.e., spending increases in recessions
230
What are automatic stabalisers?
Features of fiscal policy system that automatically adjust in response to economic fluctations
231
Examples of automatic stabilisers? (2)
Taxes (they are progressive so tax revenue falls when income falls)
Benefits (they are linked to inflation & unemployment)
232
What are some policy lags?
Recognition lag
Decision lag
Implementation lag (longer for fiscal policy)
Effectiveness lag (longer for monetary policy)
233
What is the short run objectives of fiscal policy?
macroeconomic stability
234
What are the long run goals of fiscal policy?
Support sustainable economic growth
Improve equity
235
Advantages of fiscal policy (5)
targeted spending & taxation
can correct market failures
can stimulate economic growth
income redistribution
stabilise output
236
Drawbacks of fiscal policy (7)
Risk of government failure
Inefficiency
Inflexibility
Time lags
Political constraints
Crowding out
Budget deficits
237
What is crowding out?
When government spending reduces private spending
238
How does increased government borrowing lead to crowding out?
Increased government borrowing raises interest rates, which means private firms borrow less as it’s now more expensive, and therefore they invest less.
239
What is financial crowding out?
When government borrowing causes higher interest rates reducing private investment
240
What are the effects of a budget deficit? (8)
rise in national debt
higher debt interest payments
increase in aggregate demand
potential for crowding out
possible increase in interest rates
stimulate economic activity
potential inflationary pressure
potential depreciation of currency
241
What is the Taylor Rule?
A monetary policy guideline that suggests how central banks should set interest rates based on inflation and economic output gaps
242
What does the Taylor Rule suggest when inflation rises above target?
Increase interest rates
243
What does the Taylor Rule suggest when output is below potential GDP?
reduce interest rates
244
How does the Taylor Rule support inflation targeting?
It provides a structured, rule-based method to adjust interest rates when inflation deviates from its target
245
Do central banks follow the Taylor rule?
No, but many use it as a reference alongside other tools and judgements
246
What does the Phillips Curve suggest?
A stable and inverse relationship between inflation and unemployment
247
What does the Phillips Curve imply when there is a short run decrease in unemployment
Inflation rises due to increased wages and demand
248
Why does low unemployment lead to inflation (under the Phillips Curve)?
Labour becomes scarce, wages rise and businesses raise prices to cover higher cost of labour
249
What does a long run phillips curve look like?
vertical - there is no trade-off between inflation and unemployment in the long run
250
What is the natural rate of unemployment?
The unemployment rate at which inflation is stable
251
What is the expectations augmented phillips curve?
considers inflation expectations in the model - if people expect inflation to be high, they will demand higher wages to maintain their standard of living, leading to higher prices and inflation
252
What is the solow growth model?
It’s a long-run model of economic growth that explains how output evolves over time through capital accumulation, labour growth, and technological progress
253
Key assumptions of the Solow growth model? (8)
Constant returns to scale
Diminishing returns to capital and labour
Closed economy
Exogenous and constant savings rate
Full employment
Population growth is exogenous
Consumers save a constant fraction of their income
Savings = Investment
254
What is the steady state in the solow model?
When capital per worker and output per worker are constant over time, at this point investment equals depreciation and dilution
255
What determines long-run growth in the solow model?
technological progress
256
Can policy affect long-run growth in the solow model?
No, only exogenous technology drives long-run growth
257
What is convergence theory?
It suggests that poorer countries will grow faster than richer ones assuming they share similar fundamentals
258
What causes convergence in the Solow model?
Due to diminishing returns to capital, countries with lower capital per worker get higher marginal returns, encouraging faster growth. Richer countries, with more capital, grow more slowly
259
What is absolute convergence?
All countries converge to the same income level if they have identical structural parameters (savings, population growth, depreciation, technology)
260
What is conditional convergence?
Countries converge to their own steady states if that have different structural parameters (savings, population growth, depreciation, technology) but the gap still narrows over time
261
What is endogenous growth theory?
an economic theory that suggests long-run economic growth is primarily driven by internal factors like innovation, human capital investment, and knowledge accumulation, rather than external forces like population growth
262
What is the Human Development Index?
composite measure of a country's overall development and quality of life - beyond just GDP
263
What are the components of HDI?
Health - life expectancy at birth
Education - mean years of schooling and expected years of schooling
Standard of living - Gross national income per capita
Each component is normalised and the HDI is the geometric mean of the three
264
What does the HDI score mean?
HDI ranges from 0 to 1
Closer to 1 = higher human development
265
What are the limitations of HDI?
Doesn’t account for inequality
Misses political freedom, safety, environmental quality
Reflects long-term progress, not short-term changes
May not capture within-country disparities
266
What is the Lorenz curve?
Graphical representation of income or wealth distribution within a population
267
How is the Lorenz curve plotted?
The x-axis shows the cumulative % of the population (from poorest to richest
The y-axis shows the cumulative % of total income earned
The curve starts at (0,0) and ends at (100,100)
A straight 45° line represents perfect equality (e.g., bottom 50% earn 50% of income)
The more the Lorenz curve bows below the 45° line, the greater the inequality
268
What is the Gini coefficient?
A statistical measure of income or wealth inequality within a country
269
How is the gini coefficient estimated?
Gini = Total area under line of equality
Area between line of equality and Lorenz curve / total area under line of equality
270
What do Gini values mean?
0 is perfect equality
1 is perfect inequality
271
Keynesian demand
Sum of consumption, investment, gov spending and net exports
consumption is a function of disposable income
272
What causes a shift in the IS curve?
Changes in demand for goods at a given interest rate, e.g., tax or government spending
273
What is the IS curve derived from?
Equilibrium in the goods market and how output changes as a result of a change in interest rates
274
What is the LM curve derived from?
Equilibrium in the financial market (money supply & demand) and how changes to income affects the interest rate
275
How does contractionary fiscal policy affect the ISLM model?
Increase in taxes > lowers disposable income > decreased consumption > decrease in output and income > reduces demand for money > decrease in the interest rate
276
How does expansionary monetary policy affect the ISLM model?
Increase in money > reduces the interest rate > increased investment > increased demand and output
277
What are the three dimensions of openness (ISLM model)
Openness in goods markets
Openness in financial markets
Openness in factor markets
278
Relationship between the goods market equilibrium and the nominal interest rate and nominal exchange rate
it depends negatively on both
279
Relationship between domestic interest rate and exchange rate
positive - an increase in the domestic interest rate appreciates the value of the domestic currency
280
Under the AS model, why does an increase in output increase the price level?
Increased output > increased employment > decreased unemployment rate > increase in nominal wage > increase in price level
281
Under the AS model, why does an increase in expected price level increase the actual price level?
If wage setters expect the price level to be higher, they set a higher nominal wage > increases costs > in the prices set by firms and a higher price level
282
What does the AS curve represent?
the relationship between price level and output for a given expected price level, derived from equilibrium in the labour market
283
Under the AD model, what does the AD curve represent?
Relationship between prices and output, derived from equilibrium in the goods and financial markets
284
What is the Golden Rule of Capital Accumulation in the Solow Model?
When the savings rate maximises steady state capital per worker
