A-Level Economics-Macro Year 12

Households

Households are both consumers and suppliers of factors of production. They provide labor, land, capital, and enterprise to firms and receive income.

Labor

Work performed in exchange for wages.

Land

Rented to firms for production (rent income).

Capital

Machines or savings invested in firms (interest income).

Enterprise

Entrepreneurship to run businesses (profit).

Factor Incomes

Wages, rent, interest, profits received by households.

Equation / AD Link for Households

Their spending forms C in AD = C + I + G + (X − M).

Savings (S)

Withdrawals from the economy; consumption is an injection.

Example of Household Income

Worker earns £2,500/month wage → spends £1,800 on groceries, saves £700.

Example of Landlord Income

Landlord receives £1,000/month rent from a firm → spends part on household services.

Example of Household Savings

Household saves £500 in bank → loaned to a firm for investment (I).

Firms

Firms produce goods and services using household-supplied factors of production.

Goods and Services

Products provided by firms for consumption and investment.

Revenue

Income received by firms from sales to households (C) and government (G).

Government Spending (G)

Public services, infrastructure, subsidies provided by the government.

Taxes (T)

Income tax from households and corporation tax from firms.

Example of Government Tax Collection

Collects £500bn in taxes annually → spends £450bn on NHS, schools, roads (G).

Financial Sector

Facilitates movement of funds from savers to investors.

Welfare Payments

Payments made by the government to households.

VAT and Other Levies

Taxes collected by the government apart from income tax.

Example of Government Grant

Grants £50m to renewable energy firms → supports investment and jobs.

Loans and credit to firms

Enables investment (I)

Interest payments to savers

Payments made to individuals who save money in banks.

Repayments from firms

Payments made by firms to banks for borrowed funds.

Savings → withdrawal (S)

The process of money being taken out of the economy.

Lending to firms → injection (I)

The process of money being put into the economy through loans.

Household deposits £1,000

Bank lends £800 to a firm building a factory.

Firm invests £800k

Boosts AD through investment component (I).

Foreign Sector

Engages in trade with the domestic economy, affecting net exports (X − M).

Imports (M)

Foreign goods/services purchased by the domestic economy.

Exports (X)

Domestic goods/services sold abroad.

X → injection

Exports contribute positively to the economy.

M → withdrawal

Imports take money out of the economy.

Net exports (X − M)

Part of AD that represents the difference between exports and imports.

UK exports £2bn of pharmaceuticals to EU (X)

An example of an injection into the economy.

UK imports £1.5bn of electronics from USA (M)

An example of a withdrawal from the economy.

Net effect = +£0.5bn

Indicates a boost to AD.

AD Equation Components

C + I + G + X − M

C

Consumption: Spending by households on goods/services.

I

Investment: Spending by firms on capital goods.

G

Government: Spending by government on public goods/services.

X

Exports: Domestic goods/services sold abroad.

M

Imports: Spending on foreign goods/services.

X − M

Net Exports: Difference between exports and imports.

Aggregate Demand (AD)

Total planned spending on goods and services in an economy at a given price level.

AD = C + I + G + (X − M)

Equation representing Aggregate Demand.

Post-COVID tax cuts in the UK

Increased household spending (C) → AD shifted right.

Brexit uncertainty

Reduced business investment (I) → AD shifted left.

Consumption (C)

Household spending on goods and services; largest component of AD.

Investment (I)

Spending by firms to increase capital stock and productive capacity.

Short-Run Aggregate Supply (SRAS)

Total goods and services firms are willing to supply at different price levels in the short run. Upward sloping due to sticky wages and prices.

Long-Run Aggregate Supply (LRAS)

Maximum sustainable output of an economy at full employment; vertical at potential GDP.

Short-Run Equilibrium

Level of GDP where AD = SRAS. Determines actual output and price level in short term.

Long-Run Equilibrium

AD intersects LRAS; output at potential GDP, price level stable.

Inflationary gap

AD > SRAS at full employment → prices rise, unemployment falls temporarily.

Recessionary gap

AD < SRAS → output below potential, unemployment above natural rate.

Multiplier effect

Amplifies the impact of investment on GDP.

Business uncertainty

Can reduce investment, leading to a leftward shift in AD.

Excessive spending

May increase inflation or debt.

Positive net exports

Indicates AD increases.

Negative net exports

Indicates AD decreases.

Production costs

Sensitive to changes affecting SRAS.

Supply-side policies

Can shift LRAS.

Aging population

Reduces labor supply, shifting LRAS left.

Investment in AI and automation

Shifts LRAS right, leading to higher potential output.

Post-COVID UK surge in consumer spending

Example of an inflationary gap.

Global supply disruptions

Can cause SRAS to shift left, leading to cost-push inflation.

Fiscal and monetary policies

Can adjust short-run equilibrium.

Structural reforms

May be required for persistent gaps.

Infrastructure projects

Improve long-term potential output.

Investment in renewable energy

LRAS shifts right → potential output grows.

Declining labor force

LRAS shifts left → potential GDP falls.

Supply-side interventions

Policy aims to align AD and LRAS.

Economic Growth

Increase in real GDP or productive capacity over time. Reflects living standards and employment potential.

Short-run growth

AD ↑ → actual output ↑.

Long-run growth

LRAS shifts → potential output ↑.

UK GDP rebound in 2021

Rebounded 7.5% → short-run growth.

Technological innovation

LRAS shifts right → long-run growth.

Growth evaluation

Improves living standards and tax revenue.

Excessive short-run growth

Leads to inflation; long-run growth requires productivity improvements.

Actual vs Potential Growth

Actual growth: Real GDP change during a period.

Potential growth

Economy's maximum sustainable output.

Actual growth > potential

Indicates inflationary pressure.

Investment in infrastructure

Increases potential growth.

Gaps between actual and potential growth

Indicate cyclical fluctuations.

Inflation

Sustained increase in the general price level; reduces purchasing power.

Inflation rate

% change in CPI.

Demand-Pull Inflation

Signals strong economic activity; can lead to overheating if uncontrolled.

Cost-Push Inflation

Can reduce real incomes, cause stagflation, and harm growth.

Built-In / Wage-Price Spiral

Inflation arising from a feedback loop of wages and prices.

Imported Inflation

Reduces purchasing power; affects trade balance and competitiveness.

Monetary Policy

Central bank manages interest rates and money supply to control AD, growth, and inflation.

Bank of England base rate cut in 2020

Cut to 0.1% → stimulate AD.

Fiscal Policy

Government uses spending (G) and taxation (T) to influence AD, growth, and income distribution.

UK 2020 stimulus

G ↑, T ↓ → AD boost.