Intro to Macroeconomics

Circular flow of income model (diagram + what it shows in words)

Shows that in any given time period, the value of output produced in the economy is equal to the total income generated in producing that output, which is equal to the expenditures made to purchase that output

Leakages and injections in the circular flow of income model (briefly explain each pair)

Savings deposited in banks - firms take loans from banks
Taxes paid to govt come back as govt spending in various activities (healthcare, defense, education)
Imports means not spent in domestic economy - exports mean spending from abroad into domestic economy

Uses of measuring national output

assess an economy’s performance over time
make comparisons between countries
establish a basis for making policies that will meet economic objectives

The output method

Measures economic growth by calculating the total value of goods and services produced in a country during a specific time period

The expenditure method

Value of all spending by households on final goods and services (spending on raw materials not included)
C + I + G + X - M

Explain each component of expenditure method

C - all purchases by households on final goods and services in a year
I - spending by firms on capital goods
G - government spending on providing goods and services
X-M - value of all exports minus value of all imports

Income method

Measures national income by adding up the value of all income received by households in return for land, labor, capital, and enterprise (wages, rent, interest, profits)
(Transfer payments like welfare benefits, gifts, second-hand goods NOT counted)

GDP Definition

Gross domestic product (GDP) is defined as the total nominal market value of all final goods and services produced by firms and organizations in a country over a time period (usually a year). It includes spending by the four components, C + I + G + (X-M)

GNI (Gross National Income)

GNI is the total income received by the residents of a country, equal to the value of all final goods and services produced by the factors of production supplied by the country's residents regardless where the factors are located.

Advantages of using ‘per capita’ measurements

Accounts for population differences across countries
Accounts for population growth

Real GDP

Measure of the total value of economic nominal national output adjusted for prices changes (inflation or deflation)

GDP Deflator

Measure of the general level of inflation in the economy, showing the extent to which prices have changed over time

Price Index

Measure of the average prices in one year relative to average prices in a base year

GDP PPP

Method used to compare economic productivity and living standards between countries by accounting for differences in price levels. (using exchange rates)

GNI Formula

GNI = GDP + net income from abroad

Business cycles

Business cycles consist of short-term fluctuations in the growth of real output, which are alternating periods of expansion (increasing real output) and contraction (decreasing real output).

Expansion / Recovery

When positive growth in real GDP (slope is positive)
- Increasing real output
- Declining unemployment rate
- Inflation

Peak

Marks end of expansion (max real GDP for the cycle)
- High real output level
- Low unemployment
- Inflation (rapid rise in general price level)

Contraction

When economy starts experiencing fall in real GDP (slope is negative)
If lasts for 2 consecutive quarters, it is characterized as a recession.
- Decreasing real output
- Rising unemployment rate
- Inflation fades; if prolonged, deflation can occur

Trough

Reprents cycle’s minimum GDP, or end of contraction
- Output and employment levels ‘bottom out’

Long-term growth trend

Shows how output grows over time when cyclical fluctuations are ironed out
Output showed by this trend is known as potential output / potential GDP

Why is full unemployment/natural rate of unemployment not when everyone in the country is employed?

Some become may be between jobs, moving from one geographical area to another, training to get better job, e.t.c

Link between long-term growth trend and natural rate of unemployment

Trend shows level of output when there is ‘full employment’ — unemployment is equal to natural rate of unemployment

Above potential GDP = unemployment lower than natural rate
Below potential GDP = unemployment higher than natural rate

Natural rate of unemployment

Unemployment that occurs when the economy is producing at its potential or full employment level of output (real GDP), and is equal to the sum of structural, frictional plus seasonal unemployment

Potential GDP

The level of output (real GDP) that can be produced when there is ‘full employment’，meaning that unemployment is equal to the natural rate of unemploymet

Reasons to study the business cycle

Reduce the intensity of contractions and expansions (reduces impact of rising price levels in expansions and unemployment in contractions)

Increase steepness of long term growth trend

Economic slowdown

When economy/GDP is still growing but at a slower rate than before

Green GDP

GDP that accounts for the value of resources and environmental destruction

Green GDP = GDP - environmental degradation - P

P stands for expenditure for cleaning pollution, avoiding further environmental damage and healthcare costs of pollution-induced diseases)

Reasons why GDP/GNI do not measure the ‘true’ value of output [6 - NUQNDD)

Do not include non-marketed output (some output of goods and services is not sold in the market and does not generate any income)

GDP/GNI do not include output sold in underground/parallel markets

Do not account for quality improvements in goods and services

Do not account for negative externalities; undesirable byproducts of production

Do not account for the depletion of natural resources

Differing domestic price levels (can be resolved by using GDP PPP)

Reasons GDP/GNI cannot accurately measure economic well-being

Do not make distinctions between compositions of output (some goods/services contribute more to standards of living that others)

Do not reflect achievements in levels of education, health, and life expectancy

No information of distribution of income

Do not represent working hours / leisure time

Do not account for quality of life factors (e.g: crime rate, political freedom)

OECD Better Life Index

Measures standards of living based on a number of factors the member countries themselves have selected as factors that make a better life

Happniess Index

Alternative to national income as a measure of well-being as it considers how technology, governance and social norms influence communities and their level of well-being

Happy Planet Index

Shows the ecological efficiency with which human well-being is delivered around the world. Tells us how well nations are doing at achieving long, happy, and sustainable lives.

inequality of outcomes - inequalities between people with regard to life expectancy and well-being

Aggregate Demand

The total amount of real output (real GDP) that consumers, firms, the government, and foreigners want to buy at each possible price level, over a particular time period.

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

Effect of AD shifts explanation

Rightward shift = increae in aggregate demand = for any price level, a larger amount of real GDP is demanded (vice versa)

Causes of changes in C (consumer expenditure)

Consumer confidence (of future economic situation, determining whether they spend or save AND future price levels)

Interest rates (if low, borrow and spend more now)

Wealth (value of assets people own; makes people feel wealthier and so spend more)

Income tax level

Household indebtedness

Age and structure of population (old = less spending)

Distrubution of income (low-income spend more improving lifestyle compared to high-income that may invest or save instead)

Causes of changes in investment (I)

Business confidence (about future sales and activity)

Interest rates (borrowing)

Improvements in technology (investment to adapt it)

Corporation tax

Levels of RDI (real disposable income — determines whehter households can invest)

Corporate indebtedness

Legal/institutional changes

Government spending

Spending undertaken by the government as part of its fiscal policy or as part of an effort to meet particular economic or social objectives

Causes for changes in government spending (G)

Changes in political priorities (choice to decrease provision of subsidies/merit goods; e.g. desire to please electorate)

Change in economic priorities (deliberate efforts to infleunce aggregate demand)

Threats of war/terrorist attacks/ rises in crime

Causes for changes in net exports (X-M)

RDI abroad

RDI in the domestic country

Exchange rate

Level of trade protection

Aggregate supply

The total output of goods and services that producers in an economy are willing and able to supply at different price levels in a given time period

Short-run aggregate supply (SRAS)

The short-run aggregate supply curve (SRAS) shows the relationship between the price level and the quantity of real output (real GDP) produced by firms when resource prices (especially wages) do not change.

Slopes upwards because of firm profitability

Effect of SRAS shift explanation

Rightward shift means short-run aggregate supply increases; for any particular price level, firms produce a larger quantity of real GDP (vice versa)

Factors shifting SRAS curve

Wages (drop means cost of production drop so SRAS shifts right)

Non-labor resource prices (oil, equipment, land inputs, etc)

Indirect taxes (treated by firms as costs of production)

Subsidies

Shock factors (like weather)

Macroeconomic equilibrium

Where aggregate demand and aggregate supply are equal

Long-run aggregate supply (LRAS)

The total quantity of goods and services (real output or real GDP) produced in an economy in the long run (when wages and other resource prices change to reflect changes in the price level), ceteris paribus.

Represents potential ouput / full employment

Long-run equilibrium (or short-run full employment equilibrium)

When AD and SRAS intersect at a point on the LRAS curve

Recessionary (deflationary) gap

When equilibrium real GDP is less than potential GDP (unemployment is greater than natural rate) — not enough demand in the economy for to make it worthwhile for firms to produce at potential GDP

Inflationary gap

When equilibrium real GDP is greater than the potential GDP (unemployment is less than natural rate) — too much demand in the economy

Reasons why the AD curve slopes from left to right

The wealth effect (fall in price level increases amount of goods and services wealth can buy)
Interest rates effect (rise in price levels mean interest rates rise, leading to less consumption and AD)
International trade effect (rise in price level → products less competitive → imports are bought by domestic consumers → contraction)