macroeconomics

Unemployment

People of working age who are without work, available for work, and actively seeking employment.

Keynesian economics response to recession

Government spending encouraged. Deficit spending will create more jobs —> more consumer confidence —> more consumption —> more tax revenue

New-classical economics response to recession

Government spending discouraged: artificial increase in AD is met with an upwards pressure in price level —> wages increase —> producing becomes more expensive so SRAS shifts left —> creates stagflation. No gov spending: economy will correct itself in the long run

Fiscal policy

Government policy that attempts to manage the economy by controlling taxing and spending.

Expansionary fiscal policy

increases aggregate demand

Contractionary fiscal policy

reduces aggregate demand

Monetary policy

The use of interest rates and the money supply by the Central Bank to influence AD

Expansionary monetary policy

Increases money supply to stimulate economy

Contractionary monetary policy

Decreases money supply to control inflation.

Demand-side policy

Aim to change AD level

Unemployment diagrams

Interventionist supply-side

Aims to increase the quality and quantity of factors of production through government intervention

Market-based supply-side

Aims to increase the quality and quantity of the factors of production by allowing markets to operate more freely

Demand vs supply side policies

Demand-side policies change AD but supply-side policies change LRAS

Inflation

A sustained increase in the general price level over a period of time

Central bank

an institution designed to oversee the banking system and regulate the quantity of money in the economy

Base rate

The minimum lending interest rate in the economy, controlled by the Central Bank

Interest rate

The cost of borrowing money

GDP

Gross Domestic Product- the total monetary value of all final goods and services produced within an economy in a given period of time

GNI

Gross National Income- the total income of a nation's people and businesses

Expenditure method of calculating national income

the total amount spent on goods and services made in the country, minus imports: C+I+G+(X-M)

Supply-side policy

Government policy that aims to increase aggregate supply by improving the quality and quantity of the factors of production in an economy.

Output method of calculating national income

Final monetary value of goods and services - value added at each intermediate step. Only the final value is counted and the value at intermediate steps is subtracted to avoid double counting.

Price deflator for rGDP

100 + inflation r%

Income method of calculating national income

Method of calculating national income by measuring the aggregate value of final factor payments made (= income) in an economy over a period of time.

Labour force

employed + unemployed (everyone willing and able to work)

Budget deficit

government spending > tax revenue

Budget surplus

Government spending < tax revenue

3 types of government expenditure

Current expenditure, capital expenditure, transfer payments

Transfer payments

payments by the government to redistribute income to those unable to work

Capital expenditure

Long-term investment in new government-financed infrastructure. Counts as G in expenditure

Income tax

A tax on people's earnings

Determinants of Consumption (C)

1. Consumer confidence 2. Income tax 3. Interest rates 4. Changes to wealth

Determinants of Government spending (G)

1. Political objectives of the government 2. Short and long-term needs of the economy

Determinants of imports and exports (X-M)

1. Exchange rate 2. Economic environment elsewhere (in other countries) 3. Competitiveness of goods and services

Determinants of Investment (I)

1. Business confidence 2. Corporate tax 3. Interest rates 4. Level of consumer spending

business cycle

Alternating periods of economic expansion and economic recession

4 phases of the business cycle

expansion, peak, contraction, trough

Recession

At least 2 quarters (6 months) of negative real GDP growth

Aggregate Demand (AD)

Total expenditure on goods and services in a given period of time at a given price level

Laissez-faire

The invisible hand: leaving the economy alone and expecting price mechanism to correct disequilibrium

Circular flow of income

A model that illustrates the interactions between economic agents in an economy

Injections

Flow of money into the circular flow of income from outside (not consumers), G, I and X

Leakages

withdrawals from an economy's circular flow, S, T and M

open economy

an economy that interacts freely with other economies around the world

inflationary gap

aggregate demand is greater than potential output

Advantages of GDP as a measure of economic wellbeing

1. Allows comparison between countries

2. Informs policymakers

3. GDP per capita gives indication of average income

Disadvantages of GDP as a measure of economic wellbeing

1. Overestimates quality of life

2. Does not account for disparity in income distribution

3. Contains inaccuracies

4. Does not account for improvements in quality of output if monetary value is the same

Nominal GDP

GDP measured in current prices

Real GDP

GDP adjusted for inflation

How to calculate real GDP

(Nominal GDP/GDP Deflator) x 100

Deflationary gap

aggregate demand is not sufficient to buy up the potential output

Assumptions of new classical model

Prices and wages are flexible, the market corrects itself

Assumptions of the Keynesian Model

Rigid prices and wages (sticky downwards)

Goals of monetary policy

Low and stable rate of inflation Low unemployment Reduce business cycle fluctuations Promote a stable economic environment for long-term growth External balance

real interest rate

nominal interest rate - inflation rate

Strengths of effectiveness of monetary policy

1. Incremental, flexible and easily reversible (Bank of England meets ~8 times a year)

2. Interest rates affect C, the largest component of AD, so they have a large impact

3. If interest rates are cut, there is a long run impact on LRAS because there is more investment I

4. Central banks are independent of the government in many HICs so their decisions are made in the interest of the country rather than politics

Constraints on effectiveness of monetary policy

1. Time lag of 12-24 months

2. Not effective if consumer and business confidence are already low (liquidity trap when r% is low but savings S is high)

3. Impact depends on magnitude of change in r%, so there is a limited scope of reducing r% when it is already close to 0

Goals of fiscal policy

Low and stable inflation Low unemployment Promote a stable economic environment for long-term growth Reduce business cycle fluctuations Equitable distribution of income External balance

Strengths of effectiveness of fiscal policy

1. Can target specific economic sectors

2. Government spending is effective in a deep recession

Constraints in effectiveness of fiscal policy

1. Political pressure (opportunity cost of government spending)

2. Debt and budget deficit

3. Time lags

Goals of supply side policies

Long-term growth by increasing the economy's productive capacity Improving competition and efficiency Reducing labour costs and unemployment through labour market flexibility Reducing inflation to improve international competitiveness Increasing firms' incentives to invest in innovation by reducing costs

Market-based policies

Competition: Deregulation, privatisation, trade liberalisation, anti-monopoly regulation Labour market: reducing power of labour unions, reducing unemployment benefits, abolishing minimum wages Incentive: personal income tax cuts, cuts in business tax and capital gains tax

Interventionist policies

• Education, training

• Improving quality, quantity and access to health care

• Research and development

• Provision of infrastructure

• Industrial policies

Strengths of effectiveness of market-based policies

1. No burden on government spending

2. May improve resource allocation (free market)

3. May improve international competitiveness (production costs decrease, FDI increases)

Strengths of effectiveness of interventionist policies

1. Direct support of sectors important for growth (e.g. tech)

2. Ability to create employment (decreasing structural unemployment)

3. Positive effects on equity (like direct investments in lower income regions)

Constraints in effectiveness of market-based policies

1. Possible negative effect on equity

2. Less tax revenue (if taxes cut)

3. Negative externalities (eg from deregulation)

4. Time lags

Constraints in effectiveness of interventionist policies

1. Time lags

2. Cost

unemployment rate

(unemployed/labor force) x 100

Consumption (C)

Spending by households on domestic goods and services for their private use

Investment (I)

The addition of capital stock by businesses to create future production capacity

Government spending (G)

Spending by the government on capital goods and services

Aggregate Supply (AS)

The sum of all goods and services that all the industries in an economy will produce at a given price level (= to output method)

Short-run aggregate supply (SRAS)

Short-run: Period of time when at least one FoP is fixed. If firms want to increase output, they need to pay more to hire FoP.

Determinants of SRAS

Changes in costs of production, e.g. for

• Change in cost of raw materials

• Change in wage rates