Theme 2- macroeconomics

Government objectives

Economic growth

Economic growth

Rise in GDP

GDP

Gross domestic product. It is the total market value of the goods and services produced in a country in a year

Actual economic growth

Increase in real incomes or real gdp

Potential economic growth

refers to an increase in the productive capacity.Usually due to increases in fops e.g land so able to produce more

‘Real’ values

takes into account inflation and removes the effects of it.r

‘nominal’ values

unadjusted for changes in average prices

Differences in volume and value

Volume- essentially quantity

Value- price x quantity of goods sold

GNI

Gross national income. Its is GDP plus net income paid into country by other countries e.g interest

Gross vs net

Gross- raw amount/income

Net- after certain deductions e.g tax

Aggregate Demand

total demands or expenditures in the economy at any given price

Formula to calculate Aggregate demand

AD=C+I+G+(X-M)

What is on the axis of the AD curve

Price level and real GDP/national output

What happens to AD when incomes increase

it increases

Why does AD increase when income does

-People have more disposable income and consume more

-firms invest more due to more profis

-gov gets more in tax so spends more

Multiplier effect

when a initial increase in injections of AD leads to a bigger overall effect on economy

What happens to AD as income decrease

It decreases

Why does AD decrease as income falls

-less disposable income so less consumption by consumers

-firms receive less profits and so invest less

--gov receive less tax and so spend less

Multiplier ratio

change/ initial injection

What is the ‘initial injection’ of multiplier ratio equation

any component of the AD equation.

Multiplier equation

K=1/ 1-MPC

Alternative multiplier equation

K=1/MPW

Marginal propensity to consume

(MPC) a measure of how much of an additional pound is spent within the economy

Marginal propensity to withdraw

a measure of how much of any extra pound earned is saved within the economy

How can interest rate decrease AD

-higher interest rates

-consumers save more

-consumption falls

-AD decreases

Why might consumption fall with high interest rate

-more expensive to borrow

-existing loans more expensive to save back

-save more of disposable income rather than spending(cant do both)

How can interest rates increase AD

-lower interest rates

-consumers consumer more because…

-consumption increases and so ad increase

Why might consumers consume more when there is low interest rates

cheaper to borrow in order to consume

less incentivised to save

How does investor confidence affect AD

Higher investor confidence=AD increases

Lower confidence = AD falls

Why does AD increase when investor confidence is high

more likely to take risks and invest, investment is a component of AD( can increase even further through the effects of investment-multiplier effect)

Example of multiplier effect

government spending on infrastructure, such as roads and bridges, which can create jobs and increase demand for goods and services.

Why does lower investor confidence decrease AD

less likely to take risks and invest, investment is a component of AD so if it falls AD falls ( it can decrease even further through the effects of lower investment-multiplier effect)

Wealth effect

an economic theory that states when consumers feel wealthier, they are more likely to spend money, thereby increasing aggregate demand.

Example of wealth effect

increased consumer spending due to rising home values or stock market gains.

How does wealth effect affect AD

consumers perceive an increase in their wealth=increase their spending= aggregate demand increases.

OR

consumers perceive an decrease in their wealth=decrease their spending= aggregate demand falls.

How may pensions affect AD

pensions fall=need to save more to retire=consumption falls=AD falls

pensions increase=less saving needed for retirement=consume more=AD increases

Aggregate supply(AS)

total supply of goods and services in an economy at a given overall price level and in a given time period.

Short run AS

the period where all factors of productions are fixed

Why does the SRAS slope upwards

increased output increases costs IN THE SHORT RUN and so price level increases

Example of costs increases in the short run when increasing output

e.g increasing output may mean workers are paid overtime which is an increase cost

When is there a contraction in AS

when price level decreases

When is there an extension in aggregate supply

when price level increases

What does an extension in AS or AD mean

real GDP has increased

What does a contraction in AS or AD mean

real GDP has fallen

Long run AS

period of time when all factors of production are variable

What are the two types of LRAS

keynesian and neoclassical

What does neoclassical LRAS curve look like

perfectly inelastic line

Why is neoclassical curve a straight vertical line(perfectly ineleastic)

neoclassical economists believe that in the long run, the economy operates at full employment

What are the three parts of keynesian LRAS

spare capacity, bottleneck and full employment

what is the ‘bottle neck’ bit of AS slope

Indicates resources are running out- almost at full employment

Spare capacity on AS curve

the’perfectly elastic’ bit of curve, additional production can occur without increased cost as there is so much spare capacity in economy - so price level doesn’t increase when increasing output

Full employment on AS curve

Where an economy cannot produce anymore, so price increases without increased output due to demand and not being able to produce more to meet it

• the perfectly’inelastic’ part of curve

When are we concerned with SRAS

when looking at change in costs

When are we concerned with LRAS

when there is a change of productivity or factors in production(our ability to produce changes:how much)

What are some things that can shift AS

Commodity prices, natural resources, investment, technology, labour costs etc

How do commodity prices shift AS

If they go up for example, firms pay more for supplies(costs are up)

can’t afford to produce as much so SRAS shifts to right

How does investment affect AS

If investment increases for example, productivity of the fops increases

LRAS Shifts to right(more efficent so productive potential increases)

What letter is used for the x-axis labelling on AD/AS diagram

y (national income), is = output=expenditure

What’s important to consider about AD/AS diagram when working with keynesian LRAS

our analysis etc depends on where our AD curve is operating against LRAS And where it shifts to(how big shift is aswell)

e.g it could go from spare capacity-bottleneck OR spare capacity and shift to where LRAS is still at spare capacity

If we have the choice what LRAS curve should we always choose

keynesian

Inflation

sustained increase in the general price level

Two causes of inflation

demand-pull inflation and cost-push inflation

Demand-pull inflation

-increase in AD

-price mechanism put prices up (rations)

-price level rise=inflation

Cost-push inflation

-Increase in costs

-reduced supply(can produce less at same price)

-prices increased=inflation

Deflation

a sustained decrease in the general price level

What is the major risk of deflation

deflationary spiral

deflationary spiral

Where lower prices lead to delay in investment/spending(anticipating even lower prices), this reduces AD and consequently leads to further decreases in prices and economic activity.

Causes of deflation

Decrease in AD

Increase in AS

What happens to the value of money with inflation

money is worth less

What happens to the value of money with deflation

value of money increases

How do we work out inflation rate

change in PL/original PL x 100

How do we calculate the price level in three steps

living costs and food surveyr

price survey(colllects data on prices in shops to find average price)

weighted average of all prices

Disinflation

Price level increases but at a smaller rate

e.g from 4% to 2% (still 2% inflation though)

Why do we use consumer price index

raw price levels take too long to calculate, so calculates more easily using a representative basket of goods to track inflation.

How to calculate index

Index=current number/base number x 100

what do we set base to when calculating index

100

Living costs and food survey

carried out by office of national statistics to gather data on consumer spending patterns in the UK.

-5000 households are interviewed about commonly brought goods and percentage of income spent

Weighted average of all prices

reflects how our spending is divided

What are the problems measuring inflation

people may have unusual spending habits

There may be a time lag

Inflation or just better quality?

Doesn’t account for mortgages

Why is the fact that some people may have unusual spending habits, a problem of measuring inflation?

those with different spending habits may have different cost of living changes in response to inflation

-CPI will not accurately measure their cost of living (or changes in it)

Why might CPI not accurately measure the cost of living for those with unusual spenidng habits

CPI only concerned with the most common goods and their proportion in weighting

those will be different for those with different/unusual spending habits. so doesn’t entirely reflect

How might a time lag be a problem with measuring inflation

CPI is only updated once a year

-but what about changes in between? e.g if there’s a new popular good and there is a change in price which affects cost of living =wont be reflected

How is the fact goods may change in quality a problem with measuring inflation?

Changes in quality can lead to inaccuracies in CPI

-may not account for improvements or declines in product quality when measuring price changes

things just may be more expensive as they are better?

What doesn’t CPI include

housing costs, tax etc.

What measure included housing costs etx

Retail price index(RPI)

RPI

How is the fact mortgage etc aren’t included in CPI a problem

changes in these costs wont be refelcted

e,g mortgage goes up, cost of living up(there’s underestimation of inflation as cpi wont included)

Possible effects of inflation

Price-wage spiral, real value of debt decreases, savings value decrease, uncertainty

Price -wage spiral

Inflation

-cost of living increases-

higher wages demandedhigher prices lead to further wage demands.

-costs increase for employers/firms

-SRAS shifts to left (can produce less)

-price level rises causing inflation(cycle repeats)

How is real value of debt increasing a positive effect of inflation?

value of money decreases so debt is worth less

means it is easier to pay of debt as it is not as much of a burden

Is the fact that the value of savings and pensions decrease a positive or negative effect of inflation

Negative. the money is worth less

How do real wages fall with inflation

If on fixed wage and prices have gone up , you can afford less

How can lower real wages in inflation be a benefit

reduces real costs for producers

Why is uncertainty a problem in inflation

more sceptical, less investment and spending lowering AD 2

Who is classed as unemployed

those who are willing AND able to work but don’t have a job

working age population

those aged 16-64

Out of the working age population what are the two groups of people

Active and Inactive

Economically active

those who are willing and able to work; job seeking or currently working

What is the economically active population broken down into

employed or unemployed