Topic 2 - How the Macroeconomy Works

Question 1

Withdrawals in the Circular Flow Model

Answer 1

Savings (S)
Taxation (T)
Imports (M)

Question 2

Injections into the Circular Flow Model

Answer 2

Investment (I)
Government spending (G)
Exports (X)

Question 3

Causes of Fall in AD

Answer 3

Fall in exports, cut in government spending, higher interest rates, decline in household wealth

Question 4

Causes of an increase in AD

Answer 4

Depreciation of the exchange rate, cuts in direct and indirect taxes, increase in house prices, expansion of supply of credit + lower interest rates

Question 5

Aggregate Supply (As)

Answer 5

Quantity of goods and services that producers are willing and able to supply at a given level of prices

Question 6

Short run aggregate supply (SRAS)

Answer 6

The relationship between planned national output and the GPL.
SRAS shoes how much output the economy can generate in the short term at each price level

Question 7

External Factors affecting Aggregate Supply

Answer 7

World oil and gas prices
Energy prices/ costs
Other mineral/ metal prices
Foodstuff prices
Import tariffs / quotas

Question 8

Long Run Aggregate Supply (LRAS)

Answer 8

In the long run, the ability of an economy to produce goods and services to meet demand based on the state of production technology and the availability and quality of factor inputs

Question 9

Shifts in SRAS

Answer 9

Change in resource (Input) Prices
Business taxes, Subsidies, regulations and imported costs
Supply shocks

Question 10

Causes of increase in AD

Answer 10

Depreciation of the exchange rate, cuts in direct and indirect taxes, increase in house prices, expansion of supply of credit + lower interest rates

Question 11

Components of Aggregate Demand

Answer 11

Household spending on goods and services (C)
Gross fixed all right in the face capital investment spending (I)
Value of the change in stocks (inventories)
Government spending (G) (Public services)
Exports of goods and services (X) minus imports of goods and services (M)

Question 12

Aggregate Demand

Answer 12

Aggregate Demand is the total level of planned real expenditure on the goods and services produced in a country

Question 12

How to calculate aggregate demand

Answer 12

C + I + G + (X-M)
Consumption + Investment + Government Spending + (Exports - Imports)

Question 13

Marginal Propensity to Consume (MPC)

Answer 13

The change in consumer spending following a change in income

Question 14

How to calculate MPC

Answer 14

Amount spent / Change in income

Question 15

Net investment

Answer 15

Gross investment - Capital depreciation

Question 16

Gross investment

Answer 16

Spending is total investment in new capital inputs. It is the total amount that the economy spends on new capital

Question 17

Net investment

Answer 17

Gross investment adjusted for capital consumption. Some new investment needed each year to replace worn out machinery

Question 18

Direct Tax

Answer 18

Must be paid e.g. income tax

Question 19

Indirect Tax

Answer 19

Doesn’t have to be paid E.g. VAT

Question 20

Multiplier Effect

Answer 20

The relationship between a change in AD and the resulting usually larger change in national income

Question 21

Positive Multiplier

Answer 21

When an initial increase in injection (or a decrease in a leakage) leads to a greater final increase in real GDP

Question 22

Negative Multiplier

Answer 22

When an initial decrease in an injection (or an increase in a leakage) leads to a greater final decrease in real GDP

Question 23

When is there a high multiplier value?

Answer 23

Economy has plenty of spare capacity to meet higher demand
Marginal Propensity to import and tax is low
High propensity to consume and extra income

Question 24

When is there a low multiplier value?

Answer 24

Economy is close to capacity limits
Propensity to import goods + services is high - extra demand leaks from circular flow
Higher inflation causes rising interest rates which then dampens other components of AD

Question 25

What determines the size of the fiscal multiplier?

Answer 25

Government Capital Investment