CHAP 4 The macro-economic environment

What is macroeconomics?

The study of the aggregated effects of decisions of individual economic units, looking at the national or international economic system as a whole.

What is macroeconomic policy?

Policies and actions a government takes to control economic issues including economic growth, inflation, employment, and the balance between exports and imports.

What are the main areas of government influence over organisations?

Overall economic policy; industry policy; environment and infrastructure policy; social policy; foreign policy.

What is the multiplier effect?

An initial increase in expenditure has a snowball effect, leading to further expenditure in the economy.

What is aggregate demand (AD)?

The sum of all demand for goods and services by individuals and businesses in a country.

What is aggregate supply (AS)?

The ability of the economy to produce goods or services.

What is fiscal policy?

A method of managing aggregate demand in the economy, set out annually in the budget.

What are the three components of fiscal policy?

Expenditure planning (spending); revenue raising (taxation); borrowing (public sector net cash requirement).

How can government increase aggregate demand using fiscal policy?

By increasing government spending and/or decreasing tax.

What are the functions of taxation?

Raise government revenue; make products reflect social costs; redistribute income and wealth; protect industries from foreign competition.

What is a direct tax?

A tax paid directly by the person to the revenue authority, e.g. income tax.

What is an indirect tax?

A tax collected via an intermediary, such as a supplier, who passes it on to the consumer.

What is a specific tax?

A fixed sum charged per unit.

What is an ad valorem tax?

A tax charged as a fixed percentage.

What is a regressive tax?

A tax that takes a higher proportion of a poor person's income than a rich person's.

What is a proportional tax?

A tax that takes the same proportion of income at all income levels.

What is a progressive tax?

A tax that takes a higher proportion of income as income rises.

What type of taxes tend to be progressive or proportional?

Direct taxes; income tax is usually progressive.

Why can indirect taxes be regressive?

When imposed on essential commodities or goods consumed by poorer people in greater quantities.

What is monetary policy?

A method of influencing aggregate demand in the economy.

What are the main types of monetary policy?

Money supply; interest rates; reserve requirements; exchange rates.

What is equilibrium of national income?

The point where aggregate demand equals aggregate supply.

What is the ideal equilibrium level of national income?

Where AD and AS are in balance at the full-employment level of national income, without an inflationary gap.

What is a deflationary gap?

A situation where demand is too low.

What is stagflation?

A combination of high unemployment and high inflation.

How can economic growth be stimulated?

By increasing aggregate demand and/or increasing aggregate supply.

What are the phases of the business cycle?

Recession; depression; recovery; boom.

What happens during a recession?

Consumer demand/confidence falls; investment becomes less profitable; orders and inventories are reduced; some companies may become insolvent.

What can cause a depression after a recession?

A lack of stimulus to aggregate demand during the recession.

What happens during economic recovery?

Confidence, output, income and employment rise; investment flows into the economy; governments may boost demand using fiscal or monetary policy.

What is a boom phase?

The phase entered once actual output rises above the trend line.

Why do governments seek to stabilise the economic system?

To avoid the distortions caused by widely fluctuating trade cycles.

What is inflation?

An increase in general price levels, which can also manifest as a decline in the purchasing power of money.

Why can high inflation be a problem?

Redistribution of income and wealth; balance of payments effects; uncertainty over money and prices; resource costs of changing prices; possible hyperinflation; reduced growth and investment.

What are the main causes of inflation?

Demand-pull factors; cost-push factors; import-cost factors; expectations; excessive growth in the money supply.

What is unemployment?

The situation where people in the workforce are without employment and seeking work.

How is the unemployment rate calculated?

Number of unemployed ÷ total workforce × 100%.

What are flows into unemployment?

Workforce members becoming unemployed through redundancies, quitting or lay-offs; people previously outside the workforce rejoining without a job.

What are flows out of unemployment?

Unemployed people finding jobs; laid-off workers being re-employed; unemployed people stopping their search for work.

What are the consequences of unemployment?

Loss of output; loss of human capital; greater income inequality; social costs; increased burden of welfare payments.

What is real wage unemployment?

When supply of labour exceeds demand but real wages do not fall enough for the labour market to clear, e.g. due to strong trade unions or minimum wage agreements.

What is structural unemployment?

Long-term changes to industry conditions affecting employment levels, potentially concentrated in one location when a major employer closes.

What is technological unemployment?

Unemployment caused when new technology and automation reduce employment, even when output is rising.

What is cyclical (demand-deficient) unemployment?

Unemployment associated with the economic cycle: low during recovery/boom and higher during decline/recession.

What is frictional unemployment?

Temporary unemployment caused by difficulty matching workers with jobs during the transition from one job to another.

What is seasonal unemployment?

Unemployment caused by seasonal patterns of demand, e.g. in tourism and farming.

What are the four main objectives of economic policy?

Economic growth; control price inflation; full employment; balance between exports and imports.

How may economic growth be measured?

By increases in real gross domestic product (GDP) per head of the population.

What factors contribute to growth potential?

Natural resources; labour sources such as education; capital availability such as new investment; technological processes increasing productivity.

What are disadvantages of economic growth?

Faster use of natural resources; pollution; some workers may lack the new skills required; higher growth may require higher savings and reduced consumer spending in the short run.

What are the three types of balance of payments accounts?

Current account; capital account; financial account.

What is included in the current account?

Trade in goods; trade in services; income from residents employed and capital investment in other countries; transfers from interest payments and non-government payments to/from other countries.

What is the capital account?

Public sector flows of capital.

What is the financial account?

Flows of capital to and from the non-government sector.

What is the balance of trade?

The surplus or deficit on the current account only.

When is there a balance of trade deficit?

When imports are greater than exports.

When is there a balance of trade surplus?

When exports are greater than imports.

How can a current account deficit be rectified?

Currency depreciation/devaluation; restricting imports through tariffs or quotas; domestic deflation to reduce aggregate demand.