Macroeconomics Flashcards

Macroeconomics

Circular Flow of Income

  • National income measures the total value of goods and services produced by a country, including GDP, GNP, and GNI.
  • Real GDP is adjusted for inflation, while nominal GDP is not.
  • GNP includes products produced by citizens of a country, whether inside the border or not, and GDP is within a country’s borders.
  • GNI is the sum of value added by all producers who reside in a nation, plus product taxes (subtract subsidies) not included in the value of output, plus receipts of primary income from abroad.
  • Households supply firms with factors of production and receive wages and dividends in return.
  • Firms supply goods and services to households, creating a circular flow of income.
  • Savings and taxes are withdrawals from the circular flow, while government spending and exports are injections.
  • Equilibrium is reached when withdrawals equal injections.
  • Full employment income is the total output when unemployment is minimized, accounting for frictional unemployment.
  • Income=Output=ExpenditureIncome = Output = Expenditure in the circular flow.

Aggregate Demand (AD)

  • Definition: Total demand in the economy, representing spending by consumers, firms, government, and overseas entities.
  • Formula: AD=C+I+G+(X–M)AD = C + I + G + (X – M)
  • Movements along the AD curve are caused by changes in the price level.
  • Downward slope explained by:
    • Wealth effect: Higher prices decrease real incomes.
    • Trade effect: High domestic inflation increases imports and decreases net exports.
    • Interest rate effect: High inflation leads to higher interest rates, discouraging spending.

Shifts in the AD Curve

  • Caused by changes in the components of AD (C, I, G, X-M) independent of price level changes.
  • Factors affecting Consumption (C):
    • Real disposable income: Higher income increases consumption.
    • Interest rates: Lower rates encourage borrowing and spending.
    • Wealth (Asset prices): Higher asset values increase consumer confidence and spending.
    • Consumer confidence: Optimism about the economy increases spending.
    • Household indebtedness: High debt reduces spending.
    • Anticipated inflation: Expectations of inflation may lead to increased immediate consumption.
  • Factors affecting Savings:
    • Real disposable income: Higher income increases saving.
    • Interest rates: Higher rates increase the incentive to save.
    • Consumer confidence: Low confidence increases saving.
    • Range and trustworthiness of financial institutions: Poor financial infrastructure reduces saving.
    • Tax incentives: Incentives increase saving.
  • Factors affecting Investment (I):
    • Interest rates: Lower rates reduce borrowing costs.
    • Business confidence: Optimism increases investment.
    • Accelerator process: Investment is related to the change in GDP.
    • Corporation tax: Lower taxes increase retained profits for investment.
    • Capacity utilization: High utilization encourages investment.
    • Growth of technology and competition: Increases investment.
    • Price of capital: Lower prices increase investment.
  • Factors affecting Government Spending (G):
    • Influence economic activity.
    • Correct market failures.
    • Reduce inequality.
  • Factors affecting Net Exports (X-M):
    • Exchange rates: Weak exchange rates increase exports and decrease imports.
    • Real disposable income abroad: Higher income abroad increases exports.
    • Real disposable income at home: Lower income at home decreases imports.
    • Government restrictions on free trade: Barriers reduce exports.

Multiplier Process

  • Definition: An initial increase in AD leads to a larger increase in national income.
  • Significance: Impacts the magnitude of AD shifts; larger with spare capacity.
  • Reverse multiplier: A withdrawal can lead to a larger decrease in income.
  • Multiplier Formula: 1/(1−MPC)1/(1-MPC)

Aggregate Supply (AS)

  • Definition: Quantity of real GDP supplied at different price levels.

Short-Run Aggregate Supply (SRAS)

  • Upward sloping: Higher prices encourage more supply.
  • Movements along the SRAS curve are caused by changes in the price level.
  • Shifts in SRAS are caused by changes in:
    • Raw material prices.
    • Business taxes.
    • Wage rates.
    • Prices of imported commodities due to exchange rates.

Long-Run Aggregate Supply (LRAS)

  • Shows the potential supply of an economy in the long run.
  • Classical LRAS: Vertical at full employment level of output.
  • Keynesian LRAS: Shaped by spare capacity; horizontal at low levels of Real GDP, vertical when no spare capacity exists.

Factors Shifting LRAS Curve (Q2 CELL)

  • Labour Productivity: Improvements in education and training.
  • Investment: Spending on new capital and technology.
  • Infrastructure Improvements: Reduce costs of production.
  • Competition: Increased efficiency.
  • Immigration: Increases the size of the labor force.
  • Institutional Structure: Strong financial intermediaries.

Macroeconomic Equilibrium

  • Equilibrium: Withdrawals = Injections, or AD = AS.
  • Classical Model: LRAS is vertical; increased AD only raises price level.
  • Keynesian Model: Equilibrium can occur below full employment; government intervention can increase demand.