Topic 2 - How the macro-economy works

What does income measure?

The flow of money a person or economy receives each year

What is wealth?

The sum, or stock, of a person or economy’s assets

What is a dividend?

A share of the profit from the company you own shares in

Explain why national income equals national spending which equals national output

National expenditure from households must come from the total income they earn. Households spend national income on the national output of goods and services produced by firms in an economy.

What is national income?

Total value of goods and services a country produces

What is gross domestic product?

The total monetary value of all finished goods and services produced within a country’s borders during a specific period, typically a quarter or a year

What is real GDP?

The value of GDP adjusted for inflation

What is nominal GDP?

The value of GDP without being adjusted for inflation

What is gross national product?

The total market value of all goods and services provided by a country, equal to GDP plus net income from foreign investments

What is gross national income?

The total income earned by a country’s residents and businesses in a given period, including income earned from abroad

How is gross national income calculated?

GDP plus net income from abroad

What is an injection?

Money which enters the economy

What are three examples of injections?

Government spending, investment and exports (GIX)

What is a withdrawal?

Money which leaves the economy

What are three examples of withdrawals/leakages?

Savings, imports and taxes (SIT)

When does the economy reach a state of equilibrium?

Rate of withdrawals = Rate of injections

How do we measure national output?

Real GDP

When leakages are greater than injections what happens to the economy?

The economy will become smaller because more money is leaving the country than entering

What is aggregate demand?

The demand for all the goods in the economy added up

What is the formula for aggregate demand?

C + I + G + (X-M)

When price level increases what happens to aggregate demand?

A contraction

When price level decreases what happens to aggregate demand?

An extension

What is disposable income?

Income left after taxes

What is the multiplier effect?

When an initial increase in injections leads to a larger increase in aggregate demand

How is the multiplier ratio calculated?

Total change in GDP / Initial injection

What is the formula for the multiplier ratio?

1 / MPS or 1/1 - MPC

What is the downward multiplier effect?

When an initial increase in withdrawals can lead to a larger decrease in aggregate demand

What is the accelerator effect?

When an increase in real GDP signals to firms that consumers are demanding more, leading to an increase in capital investment

What are benefits and what are they shown as in the AD formula?

Payments made to the unemployed or low income workers shown as an increase in consumption in the AD formula because the households will spend the money, not the government.

What is the evaluation for spending on benefits?

There is an opportunity cost as the government has to give up on spending on other projects such as the HS2

What is interest?

The reward for saving and the cost of borrowing

What does animal spirits refer to?

Investor confidence

What is the wealth effect?

When a change in wealth makes consumers feel more or less confident, changing their spending decisions

What happens if pension increases?

Less saving, more spending, shifting AD to the right.

What is the savings ratio?

The percentage of disposable income consumers will save

What does short run mean?

When at least one factor of production is fixed

Why does the short run aggregate supply curve slope upwards?

Increased output in the short run increases costs, increasing prices

Why is the SRAS curve upward sloping?

To increase output in the short run, firms have to pay workers overtime pay, increasing costs of production, meaning that prices have to rise to keep the same profits

What does the long run mean in economics?

All factors of production are variable

When quantity / productivity of the factors of production change what supply curve shifts?

LRAS

When costs change what supply curve shifts?

SRAS

What evaluation can you use for AD on the keynesian LRAS?

However, the effects on the economy depends on where along the LRAS the economy is. If our initial equilibrium is at spare capacity, YEPLE, a decrease in AD to AD1 will not affect the price level, only real GDP will decrease

What is VAT?

An indirect tax paid on goods at each stage of production or distribution

How much is VAT in the UK?

20%