Oct Test Flashcards
Macro-Economics Objective No.1
Stable prices; the Government’s inflation target is 2.0% for the consumer price index
Macro-Economics Objective No.2
Sustainable and stable economic growth and development:
Growth of real Gross Domestic Product (GDP), sustainable in keeping inflation low and reducing the environmental impact of growth.
Macro-Economics Objective No.3
Low unemployment: the government wants to achieve an increase in employment and eventually arrive at a situations where all those able and available can find meaningful work.
Macro-Economics Objective No.4
Balanced budget: the government wants to achieve a situation where total revenues are equal or greater than total expenses.
Macro-Economics Objective No.5
Greater income equality: the government wants to reduce the excessive gap between the rich and the poor, but still enough to create incentives to work.
Macro-Economics Objective No.6
Current account balance: the government wants to avoid “large” deficit on the current account balance of payments
Macro-Economics Objective No.7
Environmental sustainability: care for the environment means protecting it from misuse and overuse.
The environment is increasingly recognised an important asset that needs to be protected
Factor of Production
The inputs to the production process; land, labour, capital and enterprise.
Factor of Production No.1
Land: not only the land itself but all the natural resources below the earth, on the ground, in the atmosphere and in the sea.
E.g. gold deposits, rainwater, gold, oil, copper and natural forests.
Factor of Production No.2
Labour: the workforce of the economy.
E.g. doctors, policemen, and cabinet ministers.
The value of a worker is called their “human capital”; education and training will increase that human capital, enabling the worker to be more productive.
Factor of Production No.3
Capital; manufactured stock of tools, machines, factories, offices, roads and other resources which are used in the production of goods and services
Working / Circulating capital: stocks of raw materials, semi-manufactured and finished goods waiting to be sold.
Fixed capital: the stock of factories, offices, plant and machinery (fixed capital is fixed in the sense that it won’t be transformed into a final product as working capital will)
Factor of Production No.4
Enterprise; the seeking out of profitable opportunities for production and taking risks in attempting to exploit these.
Entrepreneurs are individuals who organise the factors of production (land, labour, and capital) and take risks with their own money and the financial capital of others.
Reward for Each Factor of Production
Land: Rent / the owners may receive a royalty (a share of the money raised in sales of the resource)
Labour: Wages / Salary
Capital: Rent + Interest
Enterprise: Profit
Circular Flow of Income Definition
A model of the economy depicting the flow of goods, services and factors and their payments around the economy.
Circular Flow of Income- National Output (O)
The value of the flow of goods and services from firms to households
Circular Flow of Income- National Expenditure (E)
The value of spending by households on goods and services
Circular Flow of Income- Households
Own the wealth of the nation. They own the stock of the land, labour, and capital used to produce goods and services.
They supply the factors in return for income which are rents, wages, interest and profits (rewards to the factors of production).
They then use this money to buy goods and services.
Circular Flow of Income- Firms
Produce goods and services by hiring factors of production from households, then selling them back to households
National Income (Y)
The value of income paid by firms (over a period of time) to households in return for land, labour and capital.
It is equal to National Output and National Expenditure
Circular Flow of Income- Injections
Spending which does not come from households:
Investment is spending by firms on new capital equipment like factories, offices and machinery. It is also spending on stocks (or inventories) of goods which are used in the production process.
Government Spending is spending by central and local government as well as the government agencies
Exports is spending by foreigners on goods and services made in the UK.
Circular Flow of Income- Withdrawal
Spending which does not flow back from households to firms:
Saving by households is money which is not spent by households. Equally, firms don’t spend all their money on wages an profits but save some of it.
Taxes paid to the government take money both from households and firms.
Imports from abroad are purchased both by households and firms. The money paid in tax then does not flow back round the circular flow of income.
Closed Economy
An economy where there is no foreign trade
Income
Rent, interest, wages and profits earned from wealth owned by economic actors
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.
E.g. physical wealth such as factories and machines is used to make goods and services
Aggregate Demand
Consumer Spending (C) + Investment (I) + Government Spending (G) + (Exports (X) - Imports (M))
Real Gross Domestic Product (GDP)
Nominal GDP - Inflation
Nominal Gross Domestic Product
GDP calculated at current prices; it is adjusted for inflation.
Real GDP + Inflation
Gross Domestic Product
A measure of the output or value added of an economy which does not include output or income from investments abroad or an allowance for the depreciation of the nation’s capital stock.
Purchasing Power Parities (PPP)
An exchange rate of one currency for another which compares how much a typical basket of goods in one county costs compared to that of another country.
GDP PPP
GDP converted to international dollars using purchasing power parity rates.
Limitations of GDP: Informal Economy
Does not take into consideration the informal economy:
Taxes such as VAT, income tax and National Insurance contributions, and government regulations such as health and safety laws, impose a burden on workers and businesses.
In the building industry, for example, it is common for workers to be self-employed and to under-declare or not declare their income at all to the tax authorities.
Transactions in the informal economy are in the form of cash as cheques, credit cards, etc could all be traced by the tax authorities.
Limitations of GDP: Home Produced Services
They are not traded and so are not reflected by GDP and does therefore not appear in national income statistics.
People are engaged in subsistence agriculture, consuming what they produce.
Hence, the value of national output in reality is much higher.
Limitations of GDP: The Value of Output Produced in the Public Sector
Valuing the output of much of the public sector is difficult because it is not purchased and sold.
This problem is circumvented by valuing non-marketed output its cost of production
In general, increased productivity in the public sector is shown by a fall in the value of output.
I.e. through more efficient staffing, the number of nurses on a hospital ward is reduced from 10 to 8 and the service is improved (though National income accounts will still show a fall in output due to a drop in the 2 nurses’ incomes)
It looks as though less is being produced when in fact output remains unchanged.
Measuring Happiness
Income: the higher the income, the happier the individual
Surveys on happiness: during the 1990s, it was discovered that happiness was associated with measurable activity in the brain which could be detected by MRI scanners.
Thus, it is physiologically possible to tell whether or not someone is telling the truth when they say they’re happy or not.
Surveys usually involve measurable indices which affect broader welfare levels: Level of literacy Access to healthcare Political freedom Quantity of leisure Income levels Pollution levels
Correlation between relative income and happiness
Physiologically, we are happy when if we feel we have more status as income is a symbol of social status.
At low levels of income, increasing income is generally agreed to increase happiness.
Rising income enables a person to purchase goods and services considered essential to the basics of life- food, shelter, healthcare and education.
However, after certain income levels, there can be a rapid diminishing marginal utility of wealth and income – with rising income doing little to increase overall utility/happiness.
Gross National Income (GNI)
The value of goods and services produced by a country over a period of time (GDP) plus net overseas interest payments and dividends (factor income)
Trade Cycle Definition
Regular fluctuations in the level of economic activity around the productive potential of the economy.
In business cycle, the economy veers from recession, when it is operating well below its productive potential, to booms when it is likely to be at or even above productive potential.
Trade Cycle- Peak or Boom
National income is high; it is likely that the economy will be working at beyond full employment.
Consumption and investment expenditure will be high, wages will be rising and profits increasing.
Tax revenues will also be high
Imports are high as well as inflation due to low unemployment.
Trade Cycle- Recession
Economic activity is at a low compared with surrounding years.
High unemployment exists, so consumption, investments and imports will be low.
There will be few inflationary pressures in the economy / there may be deflation
Trade Cycle- Downturn
Output and income fall, leading to a fall in consumption and investment.
Tax revenues begin to fall and government expenditure on benefits rise.
Wage demands are moderate as unemployment rises
Imports decline and inflationary pressures ease.
Trade Cycle- Recovery
National income and output begin to increase.
Unemployment falls.
Consumption, investment and imports begin to rise. Workers feel more confident about demanding wage increases and inflationary pressures begin to mount.
Negative Output Gap
When the economy is in recession and there is high unemployment and deflation, actual GDP will be below the trend line.
There is also spare capacity in the economy, with factories and workers lying idle when they could be producing good and services
Positive Output Gap
The actual GDP is likely to be above the trend line.
Human Capital
The value of the productive potential of an individual or group or workers.
It is made up of the skills, talents, education and training of an individual or group and represents the value of future earnings and production.
Gross National Product (GNP)
The market value of goods and services produced over a period of time through the labour or property supplied by citizens of a country both domestically (GDP) and overseas.
Informal Economy
Economic activity where trade and exchange take place but which goes unreported to the tax authorities and those collecting national income statistics.
Standard of Living
How well off is an individual, household, or economy, measured by a complex mix of variables such as income, health, the environment, participation in society and political freedoms.
Purchasing Power Parities
An exchange rate of one currency for another which compares how much a typical basket of goods in one country costs compared to that of another country.
Easterlin Paradox
According to Richard Easterlin, once a developed country passes a threshold average income, more growth doesn’t increase average reported happiness. For developed countries, higher levels of a countries GDP per capita did not relate to a higher level of happiness reported by citizens.
Easterlin Paradox Causes
Higher pollution from increased consumption. Environmental damage of higher growth
Higher levels of congestion and crowding due to more consumption and population growth.
Rising levels of inequality mean people don’t feel relatively better off.
Problem of affluence – Rise in obesity, stress of striving for higher paid work.
Factors that affect Happiness:
Income – though with diminishing returns.
Quality of work – It is not so much the income level that is important, but the sense of satisfaction that is gained from work. Boring repetitive jobs may give little joy. Self-employment or work in creative skilled jobs, give an opportunity for higher self-respect and satisfaction from work.
Leisure- If higher income is gained at the expense of leisure time, it may adversely affect happiness levels
Welfare of family members. People don’t just maximise own welfare but that of children.
Environment. Good housing, low pollution levels and natural surroundings may influence people’s happiness more than income levels.
Alternative to GDP as a measure of Living Standards (Human Development Index)
GDP is often criticised for being too one-dimensional and ignoring non monetary aspects of living standards.
The Human Development Index measures well-being using 3 indicators:
Health: as measured by life expectancy at birth
Education: measured by mean years in schooling
Income: as measured by GNI (PPP)
Alternative to GDP as a measure of Living Standards (National Well-Being)
Recently, the ONS has been exploring national well-being. This includes:
Personal well-being
Supportive personal relationships
Good health
Occupation
Location of residence
Personal finance
The economy
Education and skills
Actual GDP
The current GDP at a given point in time
Potential GDP
The maximum possible output the economy can produce if it uses all available factors of production efficiently.
Output Gap
The difference between actual GDP and potential GDP, expressed a percentage of potential GDP.
(Actual GDP - Potential GDP) / Potential GDP
Why is the Output Gap a useful indicator?
In the medium-term, GDP growth is determined by the growth rate of potential output, so it is necessary to make judgements about the economy’s underlying growth potential.
Estimating the output gap allows us to judge the size of the structural budget deficit
The output gap is crucial to central banks in judging whether inflation is likely to be a problem as the economy expands.
Depreciation
The value of capital stock which has been used up or worn out
Gross-Investment
The total amount of money spent on capital by firms including spending on new capital stock and spending to replace or repair old capital equipment
Net-Investment
Gross Investment - Depreciation 9This is the amount of investment which goes towards new (additional) capital stock.
Determinants of Consumption
Level of autonomous consumption; the level of consumption where disposal income is zero.
The MPC; the proportion of each additional unit of income which is spent on goods and services.
The level of disposable income; personal income that remains after direct taxes and government charges have been paid.
Interest rates
Changes in wealth; an increase int he value of assets causes an increase in wealth as assets generate income, and so a higher level disposable income for the consumer
Taxes; taxes reduce disposable income and so reduce consumption
Level of saving (MPS); in a recession, people save more money and so spend less (decrease in consumption)
Determinants of Investment
Rate of economic growth
Interest rates
Business confidence
Influence of government regulations
Rat elf corporation tax
Access to credit
Determinants of Government Spending
The business cycle and role of automatic stabilisers
Discretionary fiscal policy decisions
Determinants of Net Exports
Exchange rates
Economic performance in other countries
Protectionist policies
