1. National Income, AD + AS

What is macroeconomics?

Study of interrelationships between economics variables at an aggregate (economy-wide) level

What is the circular flow of income?

Model showing the flow of goods, services, money + factors of production between households + firms including withdrawals + injections

What is equal in the circular flow of income + definition?

• National income = national expenditure = national output

• National income - total value of all goods + services produced by a country within a specific period

What are withdrawals + examples?

Withdrawals - money removed from the economy

• Savings

• Taxes

• Imports

What are injections + examples?

Injections - money added to the economy

• Government spending

• Investment by firms

• Exports

What are the three states of the economy?

• Injections = withdrawls → equilibrium

• Injections > withdrawls → growing

• Injections > withdrawls → shrinking

What is income + wealth?

• Income - amount of earnings during a period

• Wealth - a stock of assets (e.g property + shares)

What is the wealth effect?

Increase in wealth or perceived increase (e.g share prices increase) → increase in spending

What is aggregate demand?

Total spending on goods + services in the economy

What is the equation for aggregate demand?

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

• C - Consumption

• I - Investment

• G - Government spending

• X - Exports

• M - Imports

• (X - M) - Net exports

What are three influences on consumption?

• Level of disposable income

• Level of saving

• Interest rates

• Consumer confidence

• Wealth effect

What are the types of investment?

• Gross Investment - amount a company invests in assets without accounting for depreciation

• Net Investment - accounts for depreciation (e.g if 5 machines bought but 2 old removed → net investment is 3 machines)

What are three influences on investment?

• Rates of economic growth

• Business expectations + confidence

• Keynes + ‘animal spirits’ - emotional + psychological factors drive decisions

• Demand for exports

• Interest rates

• Access to credit

• The influence of government + regulations

What are the two types of government spending in AD?

• Current spending (wages to public sector works)

• Capital spending on investment goods (e.g roads)

• Not transfer payments (e.g pensions)

What are the two influences on government spending?

• Trade cycle - booms, recessions + recovery cycle

• Fiscal policy preferences - expansionary + contractionary fiscal policies (e.g decrease or increase taxes)

What are three influences on net exports?

• Real income

• Exchange rates

• State of the world economy

• Degree of protectionism - how protected country is from imports (e.g tariffs/quotas)

• Non-price factors - e.g brand loyalty, advertising

Why is the AD curve that shape?

If prices increases:

• Real balance effect - saved money worth less → decreased C → AD decreases

• Interest rate effect - increased demand for borrowing → IR increases → less borrowing + increased saving → decreased C → AD decreases

• International competitiveness - SPICED → increased imports + decreased exports → X-M decreases → AD decreases

What causes a movement along the AD Curve?

Price changes → extension or contraction of AD

What are four factors that can cause a shift in the AD Curve?

Changes in:

• Consumption

• Investment

• Government

• Net exports

What are three factors that can affect the level of shift in the AD Curve?

• Multiplier effect - increased AD → increased household income → increased C → even higher AD

• Time lags - takes time to affect AD

• Accelerator model - increased AD → so business invests → even higher AD

What does marginal propensity mean?

Proportion of additional income that is used to ____ (e.g consume/save/tax/import/withdraw)

What are the five marginal propensities?

• Marginal Propensity to Consume (MPC)

• Marginal Propensity to Save (MPS)

• Marginal Propensity to Tax (MPT)

• Marginal Propensity to Import (MPM)

• Marginal Propensity to Withdraw (MPW)

What is the multiplier formula?

Multiplier = 1 / (1 - MPC)

OR

Multiplier = 1 / MPW, where MPW = MPS + MPT + MPM

What are the two problems of the multiplier?

• Difficulty measuring

• Time to come to into full effect

• Size of leakages

• Impact of trade cycle

What is aggregate supply?

Total goods + services produced in the economy at a given price level

What does the short run aggregate supply curve look like + why?

• If output increases in the short run, firms have to pay overtime/more money for quick delivery → increased costs

• This is because at least one factor of production is fixed in the short run (e.g labour → have to pay overtime)

What does the Keynesian long run aggregate supply curve look like + why?

• When there is mass unemployment, output can be increased without an increase in prices (sticky wages)

• At full employment, the economy cannot produce any more output, even if the goods can be sold for more

What does the classical long run aggregate supply curve look like + why?

At full employment, the economy cannot produce any more output, even if the goods can be sold for more

What causes a movement along the AS curve?

Price changes → extension or contraction of AS

What are the three factors that can cause a shift in the short run AS curve?

Changes in:

• Costs of raw materials / energy

• Exchange rates

• Indirect tax rates

What are three factors that can cause a shift in the long run AS curve?

Changes in:

• Relative productivity

• Education/skills

• Government regulations

• Demographic changes / migration

• Competition policy

• Technological advances

What is AS limited by?

• Spare capacity - unemployed people

• Bottlenecks - constraint which causes costs of AS to rise as the economy grows