National and International Economy Flashcards
What are the three injections
Investment
Government spending
Exports
What are the three withdrawals
Savings
Taxation
Imports
Define marginal propensity to consume
The increase in consumption following an increase in income. Specifically, how much consumption increases per £ of additional income.
How do you calculate the multiplier
Multiplier = 1/(1 - mpc)
Multiplier = 1 / (mps + mpt + mpm)
How do you use the multiplier
Multiplier x injection = total increase in GDP
Define the multiplier effect
When an injection into the circular flow leads to a greater proportional increase in AD
Define the accelerator effect
An economic postulation whereby investment expenditure increases when aggregate demand/national income increases
Explain the accelerator effect
1) Increase in consumer demand
2) Firms get close to full capacity
3) Firms invest to meet rising demand and increase capacity
Define an economic shock
An unexpected or unpredictable event that effects the economy
What two ways can shocks be categorised
1) demand-side or supply-side
2) positive or negative
What are world demand shocks
Shocks associated with a rise or a decline in spending and confidence abroad
What are world supply/price shocks
Shocks that affect the global supply and the price of goods and services
Give 2 supply side shocks that have resulted from COVID-19
1) fall in productivity due to disrupted economic supply chains, temporary business closures and growth in business bankruptcies
2) a fall in business investment due to a loss of confidence
Give a demand side shocks as a result of COVID-19
1) Sharp fall in consumer demand due to shop closures, leading to a rise in unemployment and a rise in redundancies
Give 3 points of evaluation when analysing economic shocks
1) the size of the shock - a slowdown is not the same as a recession
2) the scale of the shock- regional vs global
3) what are the multiplier/accelerator effects?
4) Can economic policy respond - is the response likely to be effective?
What can demand and supply side shocks cause
Cyclical instability - leading to booms and slumps in the economy
What is another cause of cyclical instability
Confidence
1) when the economy shows signs of instability, consumers and firms become risk averse
2) may lead to individuals saving a larger % of their income
3) larger saving rate can cause a larger fall in output and thus more instability
(Made worse by herding habits)
What could exacerbate economic cyclical instability?
The interaction of the multiplier and the accelerator
Define macroeconomic stability
The absence of excessive fluctuations in the macroeconomy, key economic indicators are in balance
Give 3 ways macroeconomic stability can be measured
1) the size and volatility of inflation
2) changes and amount in/of unemployment
3) the stability of the exchange rate in currency markets
4) real GDP growth over one or more business cycles
Give 2 benefits of a stable economy
1) stable low inflation encourages higher investment which is a determinant of improved productivity
2) stable inflation helps maintain price competitiveness for exporters
3) stability breeds higher levels of consumer and business confidence - drives spending into the circular flow
How may economic growth and environmental sustainability conflict
1) increased growth = increased AD
2) firms produce more the meet to increased AD
3) more production leads to increased pollution and increased use of land
4) leads to polluting the planted and depleting natural resources
5) leads to decreased environmental sustainability
How may economic growth and income distribution conflict
1) economic growth often creates the best opportunities for those who are highly skilled and educated
2) worsens income inequality
How may economic growth and a balanced, stable balance of payments conflict
Increased AD = Increased Income = Increased Inflation = Decreased International Competitiveness = Increased Imports and Decreased Exports = Unbalanced BOP
How may economic growth and full employment conflict
Increased LRAS could cause a negative output gap, where the economy operates below full employment
What does the Lorenz curve show
Income distribution within an economy
What can be calculated from a Lorenz curve, and what does it show
The Gini coefficient
(Smaller Gini coefficient = more income EQUALITY)
What does the quantity theory of money state
That there is a direct relationship between the quantity of money in the economy and the price level
What is Fisher’s equation, and explain what each term means
MV = PT
M = money supply
V = velocity of circulation (how many times money changes hands)
P = price level
T = volume of transactions of goods and services
What does the theory around the quantity theory of money assume
That V and T are constant in the short term
Therefore any increase in the money supply will directly lead to an increase in the price level
Explain the process of quantitative easing
1) the central bank creates money electronically
2) this money is used to purchase financial assets - mainly government bonds
3) more demand leads to increased price for assets, e.g higher bond prices
4) rise is bond prices leads to a lower yield on the bonds
5) this leads to reduced interest rates
6) also, more liquidity for banks to loan causes an increase in the supply of loanable funds, also reducing interest rates
7) lower interest rates and increased cash in the banking system should stimulation consumption and investment, hence growth
What is a liquidity trap
A term originally used by Keynes to describe a situation when even low nominal interest rates have little effect on AD because of low consumer and business confidence, and a fragile banking system
What real life impact has quantitative easing had?
- Estimated to have cut long term interest rates by 1%
- making it easier for companies to issue bonds and for people to get cheaper mortgages
- helps avoid the threat of deflation
What does the MV part of Fisher’s equation represent
Expenditure (what is bought)
What does the PT part of Fisher’s equality represent
Output (what is sold)
Why does an increase in the money supply increase the price level
More money chasing the same quantity of goods and services will put upward pressure on prices
What is an evaluation point on the quantity theory of money?
- Keynesian economists argue that V and T are not fixed and are not stable
- Therefore there is not a direct relationship between M and P
Define inflation
The sustained rise in the average price of goods and services in an economy in a given period of time
Define disinflation
A fall in the inflation rate, the general price level is increasing at a slower rate
Define deflation
A decrease in the general price level - a negative inflation raye
How is inflation measured
Measured by calculating the average weighted increase in the price of a typical basket of goods over a period of time
What are the two main ways of measuring inflation
1) consumer price index
2) retail price index (takes house prices into account)
How is a typical basket of goods determined
It is made to reflect the spending habits of individuals
