Unit 2- Macroeconomic Performance and Policy Flashcards
This covers Unit 2 content.
What are the main macroeconomic objectives of a government?
Sustainable economic growth
Price stability
Full employment
Balanced balance of payments
Reduced income inequality
Define Gross Domestic Product (GDP)
GDP measures the total monetary value of all goods and services produced within a country during a specific period.
What is inflation?
Inflation is a general increase in the prices of goods and services in an economy. This is usually measured using a consumer price index.
What are the types of inflation?
Demand-pull and cost-push inflation.
What is demand-pull inflation?
Demand-pull inflation occurs when aggregate demand in an economy is more than aggregate supply.
What is cost-push inflation?
This is a type of inflation caused by increases in the cost of important goods or services where no suitable alternative is available.
What is the difference between demand-pull and cost-push inflation?
Demand-pull inflation results from excessive aggregate demand, while cost-push inflation arises from rising production costs.
Define unemployment.
Unemployment refers to individuals who are actively seeking work but unable to find it.
Explain the types of unemployment.
Structural: Skills mismatch with job opportunities
Frictional: Transitioning between jobs
Cyclical: Due to economic downturns
Seasonal: Varies with seasonal demand.
What is economic growth?
This is an increase in the amount of goods and services produced per head of the population over a period of time.
What causes economic growth?
Labor force expansion
Increased investment
Technological innovation
Access to natural resources
Productivity improvements
What is aggregate demand?
This is the total demand for goods and services within a particular market.
What is the formula of aggregate demand?
AD=C+I+G+(X-M) where C=consumption, I=Investment, G=Government spending, X-M= Net exports.
What are the components of aggregate demand?
C: Consumption
I: Investment
G: Government spending
(X−M): Net exports (exports minus imports).
What factors influence Consumption in AD?
Disposable income: Higher income increases spending.
Interest rates: Lower rates encourage borrowing and spending.
Consumer confidence: Optimism about future income boosts spending.
Wealth effect: Rising asset values increase perceived wealth, leading to more consumption.
What factors influence Investment in AD?
Interest rates: Lower rates reduce borrowing costs for firms.
Business confidence: Firms invest more if they expect future growth.
Government policies: Tax incentives and subsidies can encourage investment.
Technological changes: Innovation drives firms to invest in new capital.
What factors influence Government Spending in AD?
Fiscal policy: Government may increase spending during economic downturns.
Political priorities: Spending depends on government objectives like infrastructure, healthcare, and education.
What factors influence Net Exports (X-M) in AD?
Exchange rates: A weaker currency makes exports cheaper and imports more expensive, increasing net exports.
Global economic conditions: Higher demand for exports arises when global economies are strong.
Trade policies: Tariffs and quotas impact the level of exports and imports.
How does a change in price level affect Aggregate Demand?
Lower real wealth: Reduces consumer spending.
Higher interest rates: Discourages investment and consumption.
Reduced international competitiveness: Decreases exports and increases imports.
What causes shifts in the Aggregate Demand curve?
Increase in AD (rightward shift):
Higher consumption, investment, or government spending.
Increase in exports or reduction in imports.
Decrease in AD (leftward shift):
Reduction in any component of AD (C, I, G, or net exports).
What is the difference between movements along the AD curve and shifts in the AD curve?
Movements along the AD curve: Caused by changes in the price level.
Shifts in the AD curve: Caused by changes in the non-price factors (C, I, G, or net exports).
What is the net trade balance?
The net trade balance is the difference between the value of a country’s exports and imports of goods and services. It is represented as (X-M), where X is exports and M is imports.
What factors influence the net trade balance?
Exchange rates: A weaker currency makes exports cheaper and imports more expensive, improving the net trade balance.
Relative inflation rates: Higher domestic inflation reduces export competitiveness and increases import demand.
Global economic conditions: Strong growth in trading partners increases demand for exports.
Domestic economic growth: Higher domestic income levels can lead to increased demand for imports.
Trade policies: Tariffs, quotas, and subsidies affect the level of exports and imports.
Productivity and competitiveness: Efficient production and quality goods make exports more attractive.
How does the exchange rate affect the net trade balance?
A depreciation (weaker currency):
Makes exports cheaper for foreign buyers → increases exports.
Makes imports more expensive → reduces imports
Net trade balance improves.
An appreciation (stronger currency):
Makes exports more expensive → reduces exports
Makes imports cheaper → increases imports
Net trade balance worsens.
What role does the global economy play in net trade balance?
When trading partner economies grow:
Demand for a country’s exports increases, improving the trade balance.
When there is a global recession:
Demand for exports falls, potentially worsening the trade balance.
What is trade surplus and trade deficit?
Trade surplus: When exports exceed imports.
Trade deficit: When imports
exceed exports.
How does domestic economic growth affect net trade balance?
Higher domestic income levels can increase import demand as consumers buy more foreign goods. This may worsen the net trade balance, especially if export growth doesn’t match import growth.
What policies can improve the net trade balance?
Supply-side policies: Increase productivity and competitiveness of exports.
Devaluation of the currency: Makes exports cheaper and imports more expensive.
Trade policies: Imposing tariffs or quotas to reduce imports (though these can lead to retaliation).
Why might a persistent trade deficit be problematic?
Leads to a reliance on borrowing or foreign investment to finance the deficit.
Increases vulnerability to external economic shocks.
May put downward pressure on the currency in the long term.
Why might a trade surplus not always be positive?
A trade surplus could indicate weak domestic consumption and over-reliance on foreign markets.
Other countries may impose retaliatory trade barriers.
How do supply-side improvements affect the net trade balance?
Improvements in productivity, quality, and innovation increase export competitiveness.
Greater production efficiency can reduce costs, making exports more attractive internationally.
What is aggregate supply?
Aggregate Supply refers to the total quantity of goods and services that producers in an economy are willing and able to supply at a given overall price level in a specific time period.
What are the types of aggregate supply?
Short-Run Aggregate Supply (SRAS) and Long-Run Aggregate Supply. (LRAS)
What is Short-Run Aggregate Supply?
This is supply that reflects output when some factors of production are fixed. It slopes upward because higher prices lead to higher output in the short run.
What is Long-Run Aggregate Supply?
This represents the economy’s maximum sustainable output when all resources are fully utilized, and all factors of production are flexible. It is vertical, reflecting that output is not influenced by price level changes in the long run.
What factors cause a shift in the SRAS curve?
Wages
Prices of raw materials
Energy costs
Changes in indirect taxes
Changes in exchange rates
Natural disasters/pandemics
What factors cause a shift in the LRAS curve?
Increased labor supply
Improved education and skills
Advances in technology
Increased investment in capital goods.
Deregulation or improved governance.
Reduced barriers to trade
Access to new resources
Why is the LRAS curve vertical?
In the long run, output is determined by the economy’s productive capacity, which depends on the quantity and quality of factors of production, not the price level. It reflects full employment and maximum efficiency.
What is the relationship between the SRAS curve and the price level?
In the short run, higher prices incentivize producers to increase output, as profit margins rise due to fixed costs. This creates the upward slope of the SRAS curve.
How does a supply-side shock impact AS?
Negative shock: Increases production costs, shifting SRAS left
Positive shock: Reduces production costs, shifting SRAS right
How do supply-side policies impact AS?
Supply side policies aim to increase LRAS by improving efficiency and productivity.
What is the significance of the Keynesian Aggregate Supply Curve?
Horizontal: Reflects spare capacity
The Upward Sloping: Reflects diminishing returns as resources become scarcer.
Vertical: Reflects full capacity, where output cannot increase further regardless of price changes.
What happens to AS during a recession?
In the short-run, SRAS may remain unchanged, but lower demand can lead to excess capacity.
Long-term effects may include reduced investment, eroding productive capacity, and a potential leftward shift of LRAS.
How does inflation affect aggregate supply?
In the short run, higher inflation may lead to higher output due to increased profit margins.
Over time, sustained inflation raises input costs, potentially shifting SRAS left.
What is the role of productivity in determining Aggregate Supply?
Higher productivity increases output per unit of input, reducing costs and shifting both SRAS and LRAS to the right.
Factors boosting productivity include technology, education and efficient allocation of resources.
Why do economists focus on increasing LRAS for long-term growth?
Increasing LRAS ensures sustainable economic growth without triggering inflationary pressure, as it raises the economy’s productive potential.
What is the impact of exchange rates on Aggregate Supply?
A weaker currency increases the cost of imports, shifting LRAS left.
A stronger currency reduces import costs, shifting SRAS right.
How does investment impact Aggregate Supply?
Investment in capital goods and technology enhances productive capacity, shifting LRAS to the right.
Short term investment can also increase SRAS by improving efficiency.
What is national income?
National income is the total monetary value of all goods and services produced within an economy over a specific period.
What are the components of National Income?
Wages and salaries
Rent
Interest
Profits
What are the three approaches to measuring national income?
Income method: Adds up all incomes earned in the economy.
Output method: Adds up the value of all goods and services produced.
Expenditure method: Adds up all spending on goods and services in the economy.
What is the difference between Gross Domestic Product and Gross National Product?
GDP: measures the total output produced within a country’s borders
GNP: Measures the total output produced by a country’s residents, regardless of location, including income earned abroad but excluding income earned domestically by foreign entities.
What is Net National Income?
NNI adjusts Gross National Income by subtracting depreciation.
How is NNI calculated?
NNI=GNI-Depreciation
What is the difference between nominal and real income?
Nominal National Income: Measured at current market prices and does not account for inflation.
Real National Income: Adjusted for inflation, reflecting the actual purchasing power.
What is the circular flow of income?
It illustrates the movement of money, goods and services in an economy between households and firms.
What are the key flows in the circular flow of income?
Households provide factors of production to firms
Firms pay wages, rent, interest and profits to households.
Households spend income on goods and services provided by firms
What are the injections in the circular flow of income?
Investment: Spending by firms on capital goods.
Government spending: Expenditure on public services and infrastructure.
Exports: Income from selling goods and services abroad.
What are the leakages in the circular flow of income?
Savings: Income not spent on consumption
Taxes: Money paid to the government
Imports: Spending on foreign goods and services
What is equilibrium in the circular flow of income?
Equilibrium occurs when total injections equal total leakages
I+G+X=S+T+M
How does an economy grow in terms of national income?
Growth occurs when injections exceed leakages, leading to an expansion of the circular flow of income and an increase in national income.
What is the multiplier effect?
The multiplier effect describes how an initial change in spending leads to a greater overall change in national income.
How is the multiplier effect calculated?
1-MPC
What is the Marginal Propensity to Consume (MPC)?
MPC is the proportion of additional income that is spent on consumption.
How is MPC calculated?
MPC= ΔC/ΔY
What is the Marginal Propensity to Save?
MPS is the proportion of additional income that is saved.
How is MPS calculated?
MPS=ΔS/ΔY
What is the output gap?
The output gap measures the difference between actual GDP and potential GDP
What are the types of output gaps?
Positive output gap: Actual GDP exceeds potential GDP
Negative output gap: Actual GDP is below potential GDP
What is the difference between GNI and NNI?
GNI: Total income earned by a country’s residents.
NNI: Adjusted GNI after accounting for depreciation of capital.
What are the limitations of using GDP as a measure of National Income?
GDP doesn’t account for:
Income inequality
Non-market activities
Environmental degradation
Quality of life or happiness
What is the informal economy, and how does it impact National Income measurement?
The informal economy includes unreported or illegal economic activities. Its existence leads to an underestimation of true national income.
What is the significance of measuring National Income?
Assess economic growth and living standards
Formulate government policies
Compare economic performance between countries
What factors influence National income growth?
Technological advancements
Labor force participation
Capital accumulation and investment
Improvements in education and productivity
Define economic growth?
Economic growth is the increase in the output of goods and services in an economy over time, typically measured by the rise in the real Gross Domestic Product (GDP)
What is the difference between short-run and long-run economic growth?
Short-run growth: An increase in real GDP due to higher utilization of existing resources
Long-run growth: An increase in an economy’s productive capacity, shifting the production possibility frontier outward.
How is economic growth measured?
Economic growth is measured by the percentage increase in real GDP over a specific period.
How is economic growth calculated?
Economic growth rate= change in real GDP/previous real GDP *100
What is the difference between nominal and real GDP?
Nominal GDP: GDP measured at current prices, not adjusted for inflation.
Real GDP: GDP adjusted for inflation, reflecting the actual increase in output.
What is the difference between actual and potential growth?
Actual growth: The percentage increase in real GDP due to higher aggregate demand (AD)
Potential growth: The increase in an economy’s productive capacity due to improvements in factors of production
What are the main causes of short-term economic growth?
Higher consumer spending
Increased investment
Greater government spending
Higher net exports
What are the main causes of long-run economic growth?
Labor: Higher employment, better education and training
Capital: Increased investment in infrastructure and technology
Natural resources: Improved use of land and raw materials.
Entrepreneurship: Increased innovation and business activity.
How does economic growth affect living standards?
Positive:
Higher income and employment
Better access to healthcare and education
Increased tax revenues for government spending
Negative:
Environmental degradation
Rising income inequality
Risk of inflation if growth is too fast.
What is the relationship between economic growth and inflation?
Demand-pull inflation: If AD grows faster than AS, prices rise, leading to inflation.
Cost-push inflation: If growth is due to rising costs, inflation may increase.
What are the relationship between economic growth and unemployment?
Higher economic growth usually reduces unemployment by creating jobs.
However, if growth is driven by automation or capital-intensive industries, structural unemployment may rise.
What is the production possibility frontier, and how does it relate to economic growth?
The PPF represents the maximum output an economy can produce with available resources.
Economic growth shifts the PPF outward, indication an increase in productive capacity.
What is the role of productivity in economic growth?
Higher productivity means more output produced per unit of output leading to higher wages, lower costs, greater international competitiveness.
What policies can governments use to promote economic growth?
Demand side policies:
Expansionary fiscal policy
Expansionary monetary policy
Supply-side policies:
Investment in education and training
Reduction in business regulations and taxes
Improved infrastructure
What is the importance of investment in economic growth?
Investment in capital goods increases productive capacity, leading to long run growth.
How does international trade affect economic growth?
Exports: Increase demand for domestic goods, boosting growth.
Imports: Provide access to cheaper or better quality inputs, improving efficiency.
What is sustainable economic growth?
This is growth that meets the needs of the present without compromising the ability of future generations to meet their needs
What are the negative consequences of rapid economic growth?
Environmental degradation
Depletion of natural resources
Worsening income inequality
Overheating of the economy, leading to inflation
What is the link between economic growth and development?
Economic growth increases GDP but may not improve living standard at all
Economic development considers wider factors like health, education and equality.
What is the role of technology in economic growth?
Technological advancements improve efficiency, reduce costs and increase output.
Why do some economies experience faster growth than others?
Differences in:
Government policies
Natural resources
Investment in education and technology
Political stability
What are the main macroeconomic objectives?
Economic growth
Full employment
Price Stability
Balance of Payments
Income Equality
Environmental Sustainability
Why is price stability important?
Reduces uncertainty for businesses and consumers
Prevents hyperinflation
Avoids deflation
Why is full employment a key macroeconomic objective?
Reduces government spending on benefits, increases tax revenues and improves living standards
What are the consequences of high unemployment?
Lower economic growth
Higher government welfare costs
Increased poverty and social issues.
What is the balance of payments?
A record of a country’s economic transactions with the rest of the world, including trade, investment and financial transfers
What are the consequences of a trade deficit?
Increased borrowing from foreign countries
Possible depreciation of the currency
Loss of jobs in domestic industries
How does economic growth impact income distribution?
Growth can increase inequality if the benefits are not shared equally.
Government policies can reduce income inequality.
Why is environmental sustainability a macroeconomic objective?
Ensures long-term economic stability.
Prevents resource depletion
Reduces costs from pollution and climate change.
What are the main macroeconomic objectives?
Monetary Policy
Fiscal Policy
Supply-side Policy
What is Monetary Policy?
Monetary Policy is the control of money supply and interest rates to influence economic activity
What is the expansionary monetary policy?
Lower interest rates and increased money supply to boost spending and investment.
What is the contractionary monetary policy?
Higher interest rates and reduced money supply to control inflation
How does interest rate affect aggregate demand?
Lower interest rates: Increased borrowing and spending
Higher interest rates: Reduced borrowing and spending
What is fiscal policy?
The use of government spending and taxation to influence the economy.
What is expansionary fiscal policy?
Higher government spending and lower taxes to boost AD and economic growth.
What is contractionary fiscal policy?
Lower government spending and higher taxes to reduce inflation and control debt.
What is the difference between a budget deficit and a budget surplus?
Budget deficit: Government spending exceeds tax revenue
Budget surplus: Tax revenue exceeds government spending
What are the risks of high government debt?
Higher interest payments
Potential credit rating downgrade
Crowding out private investment
What are supply-side policies?
Policies that are aimed at increasing productivity and long-term economic growth.
Give examples of supply-side policies.
Investment in education and training
Deregulation and privatization
Tax incentives for businesses
Infrastructure development
What are the benefits of supply side policies?
Improves efficiency and competitiveness
Increase employment
Reduce inflationary pressures
What are the drawbacks of supply-side policies?
Long-time lag to see results
High costs
Can increase inequality
Why can economic growth and price stability conflict?
Rapid growth can lead to demand-pull inflation
Why can economic growth and environmental sustainability conflict?
Lower unemployment increases wages, leading to cost-push inflation.
How can fiscal and monetary policy be used together?
Expansionary fiscal + Expansionary monetary——> Boost growth
Contractionary fiscal + Contractionary monetary —-> Control inflation
