Unit 3: macroeconomics

what is the circular flow of income

is used to explain how economic activity and national income are determined

explain the factors of the flow of income

Income to household and spending to firms

factors of production to firms and goods and services to households

leakages and injections in the economy

Leakages: savings, taxes, imports

injections: gov. spending, investments, expenditures

ways to measure economic activity

1. expenditure approach

2. income approach

3. output approach

what is the expenditure approach, and its components

counts the total spending on final new goods and services in a given year

spending: consumptions, investments, government spending, net exports (exports-imports)

what is the income approach? and its components

adds up all income earned by the factors of production within a country over a given Time period

components: wages earned by labour, rent earned by land, interest earned by capital, profits earned by entrepreneurship

output approach

measures the value of each good and service produced in the economy over a particular period of time and then sums them up in order to obtain the total value of output produced

GDP

the value of output that has been procured by factors of production within the country, regardless of who owns them

GNI

the sum of incomes of residents of an economy in a given period, regardless where they come from

nominal GDP

the GDP that isn’t adjusted for inflation

Real GDP

animal GDP adjusted for inflation

Inflation

price levels increase

deflation

price levels decrease

GDP per pcapita

an average based on national income of the country divided by country’s population

GDP deflator

nominal/real GDP *100

how can GDP overestimate well-being

• adding negative social behaviours and transactions eg. environmental damage, unhealthy products etc..

• underreporting loss of natural resources eg. degredation of forests, destruction of species etc…

How can GDP underestimate well-being

• the living period of people isn’t included

• underground markets aren’t included

• unpaid output not included

Why does GDP not provide enough info

• the composition of output unknown

• Misses out on many of aspects determining quality of life

• no info on income distribution

• doesn’t account for purchasing power

Business cycle

describes the fluctuations of national income from expansion to contraction to recovery

• trough: lowest point go recession

• recovery: an increase in GDP from recessionary period, that matches previous GDP before recession

• expansion: economy growing beyond previous level of output

• Peak: highest point in expansion

• Recession: two consecutive quarters of declining national output.

Green GDP

an estimate of a countries GDP aggregate output, that attempts to factor any output losses created by environmental degradation.

OECD

better quality index: tool to measure and compare quality of life across different countries. takes into consideration; housing, income, jobs etc..

Happiness index

ranks countries based on their happiness

happy planet index

(well being * life expectancy)/ ecological footprint

how well nations are doing at achieving long happy, sustainable lives

Aggregate demand

total demand for a nations goods and services from domestic households, firms the government and foreigners at a given price level and a given time period C.T

what are the components of AD

C, G, I, X-M

movement of AD curve

caused by changes in the PL

Shift of AD curve

if any of the 4 components change

determinant of C

• level of national income

• wealth

• real interest rates

• debts

• consumer confidence and expectations

how does wealth affect C

the net worth of an individual or household including the value of all its assets minus their liabilities

How does real interest rates affect C

If IR goes up Consumption will decrease

How do Debts affect C

the amount of money owed by households to lenders, inlcluding borrowing from banks.

in the short run consumption increases as they ahem more to spend

in the long run consumption decreases as they need to pay back

government debt: if government has high debt they will have low government spending

how does consumer confidence + expectations effect C

in economic growth confidence is high meaning higher consumption

in economy recession confidence is low so less consumption

Determinant of I

• interest rates

• business confidence

• changes and improvements in technology

• business taxes

• level of corporate indebtedness

• legal and institutional changes

how does business taxes and level of debt effect I

with higher taxes of profits, firms profits will falling meaning less likely to invest

with a high level of debt firms will invest less

Determinant of G

• political or economic priorities

What are forms of government spending

schools, national defence, roads, hospitals, subsidising firms

Aggregate supply

total amount of goods and services that all the firms in all th industries in a country will produce at every price level in a given time period C.T

Short run in Macro

period of time when prices of resources are roughly constant or inflexible (also true for wages)

long run in Macro

Time period where all resource prices are flexible and changing including wages

wages in the SR

in the short run changes in wages are not changing a lot

due to:

• minimum wagę law

• fix wage contracts for a period of time

• workers + labour unions resist wage cuts

• wage cuts—> lower productivity

what can cause shifts in the SRAS curve

• changes in wages

• changes in labour resource prices

• changes in business taxes

• changes in subsidies offered

• supply shocks

Types of LRAS

• Keynesian model

• new classical model

what is the new classical model

LRAS is perfectly inelastic at the full employment level of output.

• employment can’t be changed in the long, because or NRU

in the New classical model if the price level increases it doesn’t have any effect on the level of output.

Where is the equilibrium in an inflationary gap

on the right of the LRAS

where is the equilibrium in a recessionary gap

on the left of the LRAS

where is the equilibrium at full employment level

on the LRAS curve

what is a deflationary gap

not enough total demand in economy for firms to produce at full employment level

what is an inflationary gap

too much demand In economy, so firms cannot keep up

What is the Keynesian model

the Keynesian model assumes inflexible price and wages meaning that economy cannot move to the long run

what is section one in the kaynesian model

real GDP is low and the PL is constant, also a high unemployment

what is section 2 in the Keynesian model

GDP is increasing PL is increasing and employment increases

what is section 3 in the Keynesian model

the real GDP cannot increase more, PL is increasing rapidly, GDP can’t increase more due to firms using all available labour and other resources

what can shift the LR(AS) curve

increasing Q of FOP

quality of FOP’s

Improvements in technology

increasing efficiency

reduction in natural rate of unemployment

the macroeconomic equilibrium

a state of the economy in which aggregate demand equals aggregate supply. changes in either of them can effect PL, unemployment and inflation

SR equilibrium positions

• deflationary gap

• inflationary gap

• full employment

LR equilibrium positions

• No deflationy gaps because a fall in demand causes a recsionnary gap decreasing price levels, a fall in the PL leads to a decrease in wages shift AS back to LRAS

• No inflationary gap because and increase in the price levels causes wages to increase, shifting AS back to the equilibrium

what are demand side policies and what do they focus on.

• focus on changing AD to achieve several macroeconomic goals

• monetary and fiscal

Commercial banks

Carry out the monetary policy, financial institutions whose main fucntions are to hold deposits for customers, make loans, transfer funds and buy government bonds

what is the central bank

a government financial institution with many responsibilities such as:

• banker for the government

• banker to commercial banks

• regulators of commercial abnks

• conduct monetary policy

what are the goals of monetary policy?

• low/ stable inflation

• ow unemployment

• reduce business cycle fluctuations

• external balance between exports and imports

what is monetary policy

where the central bank uses money supply and interest rate to manage the economy.

inflation targeting

a public announcement of the target inflation, the target is between 1.5- 2.5 ±1

when does central bank use contractionary monetary policy

if the inflation is higher than the target

when does the central bank use contractionary monetary policy

if the inflation is lower than the target

money market

where demand and supply for money determined the equilibrium rate of interest

rate of interest

the price of money services

can the supply of money change

the supply of money remains unchanged unless the CB decided to change the money supply

what does an increase Sm do the IR

decrease in IR

what does a decrease. in Sm do to the IR

increases the IR

money creation

when individual deposit money bank must only keep a small percentage(reserve requirement) the remaining money they can lend

tools of monetary policy

• minimum reserve requirements: if reserve requirement decreases, commercial banks have more money to lend increasing the Sm and decreasing Sm

• changing the central banks minimum lending rate: if the lending rate set by central banks decreases than IR will decreases

what happens in expansionary monetary policy

if CB increases money supply, IR decreases, increasing C and I shift to the right of AD

what happens in Contractionary monetary policy

if Cb decreases money supply, interest rate increases, meaning C and I decreases shifting Ad to the left

real interest rate

interest rate that has been accounted for inflation

animal interest rate

interest quoted by commercial banks not accounted for inflation

government revenue

all funds that flow towards the government eg. taxes, sales of goods and services(electricity), sales of gov owned assets

Government current expenditure

spending on a day to day items that are reoccurring and that are used or consumed, school, medical supplies, proviso of subsidies

governmentt capital expenditure

public investments or production of physical capital eg roads, harbours, schools

Goverment trasnfer payments

payments to vulnerable groups eg unemployed, child support

government budget outcomes

• revenue = expenditure (balanced budget)

• revenue>expenditure (budget surplus)

• Revenue< expenditure (budget deficit

fiscal policy

manipulation by governments own expenditures to influence Level of AD, can mainly influence G

goals of fiscal policy

• low/stabel inflation

• low unemployment

• reduce business cycle fluctuations

• promote stable economic environment for long term growth

• external balance

• distribution of income

types of fiscal policy

• Expansionary: increasing in gov spending, decrease in personal income tax, decrease in business tax

• contractionary: decrease in Gov spending, increase in personal income tax, increase in business tax

crowding out theory

if government uses expansion fiscal policy by increasing G without increase R. it is forced to borrow money increase the Dm, causing IR to increase —> lower investments by private firms or crowding out of private investments.

• increase in Gov spending—< increase in AD

• increasing in sending increase Dm

• increasing IR

• leading to fall in AD