Macroeconomics (Year 1)

How to structure your answers?

K (Knowledge - start with the point) A (Application - give some real-world examples or data from the extracts) A (Analysis - the bulk of your marks: answer the question using chains, how does X lead to Y?) E (Evaluation - whether you evaluate, and the degree of your evaluation depends on the question asked but always break your analysis up and think 'what assumptions have I made / what could go wrong / why may X not actually lead to Y?)

What are the axes on the trade cycle?

$\text{Y}$ real GDP $\text{X}$ time

Why may the claimant count differ to ILO's measure of unemployment?

because the ILO measures 16-18year olds but claimant count doesn't

Who does the claimant count exclude? (5)

People under 18; People in full time education, who may still be classed as unemployed; People not eligible for contribution based JSA (they need to have paid at least two years of NI contributions); People with high savings; People on a government training scheme.

Effects of an outward shift in SRAS on the economy

1) lower prices $\rightarrow$ more output $\rightarrow$ increased derived demand for labour $\rightarrow$ more employment 2) lower prices $\rightarrow$ international competitiveness increases $\rightarrow$ more exports $\rightarrow$ AD shifts outwards $\rightarrow$ Real GDP increases

How does spare capacity affect the multiplier?

If there is a lack of spare capacity, firms will struggle to increase their production meaning that the multiplier effect may in fact be smaller than first proposed. Increases in AD may just be inflationary if the economy is producing at full output.

What is the crowding out effect? Why does it happen?

When increased government spending, often financed by borrowing, reduces private sector investment and spending. This happens because government borrowing can drive up interest rates, making it more expensive for businesses and individuals to borrow money, thus discouraging private investment.

Why do some consumers not want the most efficient form of production?

it may involve cruelty to animals or damage to environment

What is the crowding in effect? Give an example too.

When government spending increases private investment. Public spending can stimulate economic growth, creating more profitable investment opportunities. E.g. The government builds a new high-speed rail line, making it faster and cheaper to move goods, leading private companies to invest in factories and logistics.

White elephant projects - Great Eval for government spending

Projects that are poorly constructed without adequate cost-benefit analysis - can be used as an evaluation to crowding in (what if the gov project is poorly planned or collapses? May drive private investors away)

Disadvantages of export-lead growth

Susceptible to shock (war, pandemic, or partner recession) and Exchange rate risks (if domestic currency appreciates, the value of foreign earnings falls when converted back, reducing profits).

Animal spirits

Term coined by John Maynard Keynes; basically means business confidence: the mood of managers and owners of firms about the future of their industry and the wider economy. If animal spirits are low, investments will be low.

Give three evaluations as to why increased investment may not cause economic growth

1) Administrative costs, if the investment is poorly spent it may not increase growth 2) Opportunity cost, could the money have been better spent elsewhere? 3) Time lag, it may take months or years for effects to be visible.

Is national well-being and GDP per capita linked? (3)

The Easterlin Paradox suggests they are linked only to a certain point; national wellbeing assesses factors like health and relationships; it is hard to measure national wellbeing.

Formula for Real GDP

$\text{Real GDP} = \frac{\text{Nominal GDP}}{\text{GDP Deflator}} \times 100$. To find growth rate: \text{Real GDP growth } \text{%} = \text{Nominal GDP growth } \text{%} - \text{Inflation rate}

Base Year

year serving as point of comparison for other years in a price index or other statistical measure. Usually assigned the value $100$

Index number

A number showing the variation in a price or value compared with the price or value at a specified earlier time

Why can changes in quality be a problem when using the Consumer Price Index measure of inflation?

An increase in prices may be due to an improvement in quality and this is not the same as inflation.

Formula for AD

$$\text{AD} = \text{C} + \text{I} + \text{G} + (\text{X}-\text{M})$$

Real-world example of how the economic performance of other economies affects the trade balance of the UK

The slow growth of the Eurozone in 2012 to 2014 affected the UK's export sales (we require demand from Europe for our financial services)

What's the difference between gross and net investment?

Gross investment is the total amount spent on new capital assets, while net investment is gross investment minus depreciation.

How many work visas were issued in 2023

just under $500,000$!

formula for net investment

$$\text{gross investment} - \text{depreciation}$$

What is depreciation?

Put simply, it's when a machine begins to deteriorate and becomes less productive and efficient

Formula for labour productivity

$$\frac{\text{Output per time period}}{\text{number of employees}}$$

Should we use GDP to compare living standards?

GDP per capita is better; doesn't include subsistence or hidden economies; internationally recognized; doesn't show gov spending priorities or which goods are being produced.

formula for gross investment

$$\text{net investment} + \text{depreciation}$$

definition of wealth

a person's total value of all their assets

definition of income

flow of money received

factors influencing SRAS

changes in costs of raw materials and energy; changes in exchange rates; changes in tax rates; changing in tax on imports

factors influencing LRAS

technological advances; changes in relative productivity; changes in education and skills; changes in government regulations; demographic changes and migration; competition policy; minimum wage

Draw a Keynesian LRAS and explain it

Keynesian LRAS suggests an output gap can exist in the long run. At low levels activity is elastic; towards full employment output is max and inelastic. LRAS cannot increase without quality/quantity improvement in factors of production. Markets do not clear and spare capacity can exist.

Draw a Neoclassical LRAS and explain it

In the long run if the price level changes there will be no increase in output as it is assumed the economy is working at full potential

why is SRAS upward sloping

1. contracts make some wages and prices sticky 2. firms slow to adjust wages 3. menu costs 4. all industry supply curves added together are upward sloping

Draw the SRAS Diagram

SRAS curve is upward sloping showing relationship between price level and real output.

Why may a country's GNI be inaccurate?

GNI usually misses out informal employment (neither taxed nor monitored), which can account for a large proportion of national income.

What are the trends of a recession

A recession is 2 periods of consecutive negative economic growth. Trends include high unemployment, less consumption, and firms going out of business.

why may a country's GDP be higher than another's but its GDP per capita is lower

It may have a larger population, which is why GDP per capita is a better metric than GDP

What is PPP (Purchasing Power Parity)?

PPP is a method of comparing purchasing power across countries by pricing a common basket of goods in each currency. It adjusts GDP to reflect what money can actually buy, removing exchange rate volatility. Used by World Bank and IMF.

How does deflation affect PPP?

Increases it as each unit of currency can buy more than before

purchasing power parity calculation

find a basket of goods in each country and compare the price needed to purchase each basket

Why use PPP?

To improve accuracy: exchange rates are volatile; RGDP doesn't tell us price levels; PPP compares cost of living / buying power by price of comparable goods/services.

Limitations of using GDP to compare living standards (8)

Population size difference; inflation rates; exchange rates; income distribution; government expenditure; types of goods/services; underground economies; subsistence economies.

Causes of unemployment

Demand-deficiency; Occupational/Geographical immobility; Imperfect information; Seasonal, frictional, structural unemployment; Real wage inflexibility.

How to calculate unemployment

ILO survey; Claimant count

ILO Labour Force Survey

Counts those who have been out of work for 4 weeks and are ready to start within 2 weeks (provided they are age of 16 or above)

Advantage and Disadvantage of ILO survey

Advantage: used internationally, easy comparisons. Disadvantage: expensive administration costs, surveys only 6,000 households (not representative of whole UK).

Advantage and Disadvantage of Claimant Count?

Advantage: easy to measure (number of claimants). Disadvantage: stigma, won't measure those ineligible to claim but still unemployed.

How to find unemployment rate

$$\frac{\text{unemployed}}{\text{active}} \times 100$$

What will happen in the long run to real output if AD increases?

Nothing (just inflation) since classical economists believe the economy will be at full employment in the long run.

can you have a LONG RUN output gap on neoclassical. Why?

No. Classical economists believe in the long run all markets clear and Factors of Production are fully utilized without idle capacity; you cannot increase Q or Q of FoP for output gap.

Why may a government value happiness more than economic growth?

Happiness includes quality of life not just income. Gov policy (spending on leisure/sport) impacts happiness. Happiness is associated with a more productive economy.

How does the government find the happiness of its people?

Office for National Statistics national well-being survey (though people may not answer truthfully and it's based on normative statements).

Easterlin Paradox

High incomes correlate with happiness, but long term, increased income doesn't correlate with increased happiness

Incredible evaluation against the wealth effect?

Does it exist? In the UK only 50% of homeowners own their house; the other 50% are renting/saving and actually increase savings when wealth/prices increase!

Wealth effect in America

6\text{%} - Ricardo Sousa

Wealth effect in Europe

0\text{%} - Ricardo Sousa

GNI

The value of the output of goods and services produced in a country in a year, including money that leaves and enters the country

GDP

Gross Domestic Product - the total market value of all final goods and services produced annually in an economy

GNP

total market value of all goods and services produced by domestic residents + income received from abroad - income claimed by non-residents

difference between GDP and GNI

GDP measures production within boundaries; GNI measures income of all residents and businesses regardless of where it is produced.

An increase in long-run aggregate supply causes…

an increase in potential growth

collateral

something pledged as security for repayment of a loan, to be forfeited in the event of a default.

explain how aggregate supply increases if imports get cheaper

Cheaper imports from foreign suppliers create downward pressure on similar domestic goods. Domestic producers must lower prices to remain competitive.

What are excise duties?

Levies on demerit goods such as alcohol, tobacco, petrol and gambling.

How does increasing interest rates lead to more expensive exports?

1) Increased saving in UK appreciates currency value. 2) Business loans become expensive, costs increase, shifting SRAS inwards and raising prices.

Define inflation

A sustained increase in the general price level

Define disinflation

A fall in the rate of inflation.

Define deflation

a sustained decrease in the general price level

what is CPI

a measure of the overall cost of the goods and services bought by a typical consumer

what is cpi used for

monitor changes in the cost of living over time

how is CPI and CPIH different

CPIH measures the housing cost and council tax

How to calculate inflation rate

$$\frac{\text{CPI this year} - \text{CPI last year}}{\text{CPI last year}} \times 100$$

Where do they get the data for the CPI index basket?

They survey $7000$ households and then use the $700$ most-bought goods

what is the RPI?

Retail Price Index - Shows the rate of change of prices in everyday life, such as food, mortgage payments, heating and petrol

difference between RPI and CPI

Lies in what is included; RPI includes VAT, other taxes, and mortgage interest payments (excluded from CPI). RPI will likely be higher.

How to calculate CPI?

1. Fix basket (expenditure survey) 2. Find prices & assign weights (% of income) 3. Calculate cost (weights $\times$ prices) 4. Choose base year & index 5. Calculate inflation monthly.

uses of CPI and RPI? These are measured on a monthly basis

can measure UK's international competitiveness; can tell government whether to increase spending on welfare benefits or state pensions

limitations of using CPI to find the rate of inflation?

Excludes housing/mortgages; list of $700$ changed only once a year; survey accuracy issues; time lags; doesn't include quality changes; small sample response (60\text{%}); outlier fluctuations.

formula for CPI

$\text{inflation} = \frac{\text{change in index}}{\text{original index}} \times 100$. $\text{Index} = \frac{\text{Current Number}}{\text{Base Number}} \times 100$

Causes of deflation

decrease AD; increase AS

impacts of inflation on consumers?

Fall in real wages; value of savings decreases if inflation outweighs interest rate.

What is RPI

Retail Price Index - Shows the rate of change of prices in everyday life, such as food, mortgage payments, heating and petrol

How is RPI calculated?

$6000$ households take the Living costs and Food surveys and mortgages are included in this

what is RPI used for

to make monetary policy decisions

what is core inflation?

CPI minus food and energy costs

when is inflation bad for savers

if it is larger than the interest rates, their savings lose real value

why is inflation bad for those on fixed incomes

the inflation rate implies that their incomes will fall in real terms

Effects of inflation on firms

Raw material costs rise (profit margins fall); Staff demand raises (costs increase); People import more; less investment due to uncertainty.

Effect of inflation on government

national debt improves; balance of trade worsens; increased inequality (fixed income earners suffer)

Effect of inflation on workers

Fixed incomes suffer; unemployment may occur due to lack of investment and decreased motivation if real wages fall.

when is inflation good for a firm

if it is caused by an increase in demand (signals there is profit to be made)

why are weights used to calculate CPI

because it is more important to use goods that are most important in a consumer's expenditure

Why may CPI not be representative for a pensioner?

they will not be spending money on similar goods (they may spend more on heating and food)

What is demand-pull inflation?

When AD increases faster than AS, leading to an increase in the price level

wage-price Spiral

When demand-pull inflation drives workers to demand higher real wages, causing cost push inflation. For example, the cost of living crisis in 2023.

deflationary spiral (deflationary trap)

Deflation leads consumers to delay purchases; AD falls; price level falls further; delays continue. Cycle repeats.

3 benefits and consequences of high inflation

Benefits: protects from deflationary spiral, decreases real debt value, lowers firm costs via real wage decrease. Consequences: inflationary spiral/hyperinflation, savings lose value, investment uncertainty.

What is the current account?

Measures the international trade in goods and services, investment income, and net transfer payments.

What is a current account deficit?

When the VALUE of an economy's imports exceeds the value of its exports