10 How the Macroeconomy works Flashcards
THIS FLASHCARD SET IS LIMITED DUE TO FALLIBILITY OF THE AI IMPORT SERVICE. PLEASE CROSS-REFERENCE THE RELEVANT QUIZLET DECK WHEN IN DOUBT. (372 cards)
1
Q
What are the two main models for the macroeconomy?
A
- Circular flow of income model
- AD/AS model
2
Q
What is national income?
A
The flow of new output produced by an economy in a particular time period
3
Q
What is real national income?
A
The actual goods and services produced by an economy in a particular time period
4
Q
What is nominal national income?
A
The flow of output produced by an economy in a given time period in present price levels
5
Q
How can real national income be used as an indicator?
A
- Its CURRENT LEVEL indicates living standards in the economy
- Its RATE OF CHANGE measures economic growth/decline
6
Q
What is the relationship between national income, national output, and national expenditure?
A
National output = national expenditure
7
Q
How is national income measured?
A
By summing the factor incomes to the factors of production
8
Q
What is national expenditure?
A
All the spending on goods and services produced in the economy
9
Q
What is national output?
A
The gross amount of actual goods and services produced by the economy
10
Q
Why do national output, national expenditure, and national income equal each other?
A
They all essentially measure the same thing with the exception of injections/leakages to the circular flow
11
Q
How is national income calculated?
A
By summing the factor incomes to the factors of production
12
Q
How is national output calculated?
A
By summing the value of the various stages of the production process
13
Q
How is national expenditure calculated?
A
AD = C + I + G + (X - M)
14
Q
What is GDP?
A
The national output approach
15
Q
Why is the relationship between firms and consumers circular?
A
Consumers must sell their factor usefulness to receive income to pay for goods/services produced by firms
16
Q
What does the circular flow of income model represent?
A
Households on top, firms on bottom with solid lines indicating consumption and income, and dotted lines for goods and services and factor contributions.
17
Q
What is an example of a leakage from the circular flow of income?
A
Leakages to savings
18
Q
What is an example of an injection into the circular flow of income?
A
Investment by firms
19
Q
What is equilibrium national income?
A
The level of income at which withdrawals from the circular flow of income equal injections into the flow
20
Q
Is full employment income the same as equilibrium national income?
A
No - equilibrium national income is when the economy is producing on its PPF
21
Q
What happens when there is an increase in leakages above equilibrium national income?
A
Output and income rise
22
Q
In the two sector circular flow model, when is national income in equilibrium?
A
When planned savings = planned investment
23
Q
What are two reasons the two sector flow model of national income is inaccurate?
A
- Government spending
- Trade balance
24
Q
How does the two sector circular flow model change when made more accurate?
A
Leakages now include taxation and imports; injections now include government spending and exports
25
What is an open economy?
An economy open to imports/exports
26
When is equilibrium national income achieved?
When S + T + M = X + G + I
27
What is the Keynesian view of the circular flow of income model?
When S + M + T > X + G + I, AD will become deficient and may not self-correct
28
What do free market economists believe about deficient AD?
They believe it is temporary and self-correcting
29
What is the Keynesian view of recessions?
Deficient AD
30
Is the circular flow of income still the go-to among macroeconomists?
No, AD/AS is preferred now
31
What does AD stand for?
Total planned spending on real output
32
What are the components of AD?
C + I + G + (X - M)
33
Why does AD slope downwards?
It decreases due to import competitiveness
34
Is AD effectually the same as national expenditure?
No, AD measures planned spending while national expenditure measures actual spending
35
What are two reasons the AS curve is shaped the way it is?
1. Firms are motivated to maximize profits
2. Marginal costs increase as factor scarcity becomes a constraint
36
Why is there an increase in price level with output?
Firms need to be incentivized to produce more due to increasing marginal costs
37
How can a change in price levels across the economy be shown?
By changes in AD/AS
38
What are the two main causes of inflation represented by AD/AS?
1. Cost push inflation - leftward shift in SRAS
2. Demand pull inflation - rightward shift of AD
39
What are two types of inflation beyond cost push or demand pull?
1. Output inflation - reflationary inflation up to equilibrium national income
2. Money inflation - inflationary inflation above equilibrium national income
40
What causes a change in the position of the AD curve?
Components of AD only
41
What is the reason for an SRAS shift?
Changing costs of production
42
What is distinct about the LRAS curve?
It is not affected by price level
43
The LRAS position of output is the same as what?
PPF output
44
What usually causes short-run growth?
AD shifts in real output
45
What causes long-run growth?
LRAS shift
46
What are two definitions for equilibrium national income?
1. AD = SRAS
2. Injections = leakages
47
What is an economic shock?
A sudden unexpected event hitting the economy
48
What is a supply shock?
Affects AS
49
What is a demand shock?
Affects AD
50
What are four major economic shocks since 2007?
1. AD shock - 2008/09 recession
2. AS/AD shock - 2016 Brexit
3. COVID-19 (AD/AS)
4. Ukraine 2022 (AS)
51
What is consumption?
Aggregate spending on real national output by households in the economy
52
What is the opposite of consumption?
Saving
53
What are eight determinants of consumption?
1. Interest rates
2. Real income levels
3. Expected future income
4. Wealth
5. Consumer confidence
6. Inflationary expectations
7. Credit availability
8. Distribution of income
54
How do real incomes affect consumption?
Rising real incomes mean higher consumption, but not in direct proportion.
55
How does saving erode real income?
The multiplier effect cannot take place, meaning the income is not received again
56
What is the life-cycle theory of consumption?
A theory that explains consumption and saving in terms of how people expect their incomes to change over their life cycles
57
What is the main cause of wealth?
House
58
Why does rising wealth lead to rising consumption?
1. Higher confidence
2. Higher borrowing from house buyers
3. Equity withdrawals
4. Rising wealth of shareholders
59
Why does rising wealth (intangible income) lead to higher consumption?
Higher confidence you can cover the debt through borrowing
60
What is an issue with the availability of credit?
Post recession, banks became cautious about lending to those with poor credit scores
61
Why does redistributive economics to the poor increase consumption?
Higher marginal propensity to consume among the poorest
62
Why is inflation a self-fulfilling prophecy?
When inflationary confidence is low, there is a demand-side shock as people bring forward big ticket purchases, causing demand-pull inflation
63
What is Y equal to?
C + S
64
What is the personal savings ratio?
Realized or actual personal saving/personal disposable income
65
Why is the personal savings ratio a lag indicator?
Indicates future spending by measuring past propensity to consume
66
What caused the financial crisis?
A credit crunch where US banks had lent to sub-prime borrowers who could not repay their debt
67
Why is financial investment a misnomer?
It is really saving
68
What are the two types of investment that make up gross investment?
1. Net investment
2. Replacement investment
69
What is physical investment?
Investment in capital goods/services
70
What is financial investment?
Misnamed saving
71
Why is the rate of interest a key determinant of investment?
Firms will have to pay the investment borrowing off for a while into the future
72
What are six determinants of investment?
1. Business confidence of returns
2. Interest rates
3. Credit availability
4. Relative prices of capital and labour
5. Technical progress
6. Support of government
73
Why does rapid technical progress reduce investment?
Firms know better capital will be available in a short time frame
74
Why is the availability of credit a problem with investment?
Big, long-term investment is risky and banks are stingy with funds for it - PARTICULARLY HIGH TECH INVESTMENT WHERE IT IS UNTESTED.
75
What is the accelerator effect?
Firms aim to keep the capital-output ratio constant; when output increases, firms increase investment spending to maintain this ratio
76
What is economic activity?
Exchange of goods and services, including labour, in an economy
77
Why does AD affect employment?
More factors are needed to produce more goods/services
78
What is the national income multiplier?
The relationship between an initial change in AD and the resulting generally larger change in national income
79
How does the multiplier effect work?
1. A round of spending occurs in the economy
2. Recipients set some aside and spend the remaining
3. This continues until all spending has left the economy through savings
4. This creates a larger than proportional increase in AD for any injection
80
When the multiplier is 2.5, what does it mean?
An initial injection of 1 will increase national income by 2.5
81
What is the multiplier formula?
(Change in national income)/(initial change in component of AD)
82
What does MPC stand for?
Marginal propensity to consume
83
What does MPS stand for?
Marginal propensity to save
84
What is the relationship between MPS and MPC?
MPS + MPC = 1
85
Why is the national income multiplier a composite measurement?
It includes many individual multipliers for each component of AD
86
Why is the regional multiplier less than the national multiplier?
Money spent on imports from other regions
87
What leads to low multipliers?
High leakages such as savings
88
What is nominal national income equal to?
Real national income x average price level
89
What can change the size of the multiplier?
Whether it is nominal or real
90
When the SRAS curve slopes upwards, what is the relationship between real multiplier and nominal multiplier?
Nominal > Real
91
As we ascend the SRAS curve, what happens to the real multiplier?
It decreases towards zero
92
What are two determinants of SRAS?
1. Price level
2. Production costs
93
Why is the SRAS curve not linear?
Factor scarcity affects the effectiveness of monetary and fiscal policy
94
What do inflationary AD shifts mean?
We are closer to SRAS vertical with more pressure on price level than real output
95
What do reflationary AD shifts mean?
We are further from vertical SRAS and hence more increase in real output than price level
96
At full employment, what does a rise in AD lead to?
Inflationary pressure only
97
What are six reasons for an SRAS shift right?
1. A fall in costs of production
2. A fall in unit labour costs
3. A reduction in indirect taxes
4. An increase in subsidies across the economy
5. Technical progress
6. Increase in exchange rate
98
What determines aggregate supply for the market period?
Price level
99
Why is the LRAS curve vertical?
In the extreme long run, price level does not influence aggregate quantity supplied
100
Where is the LRAS curve located?
At the normal capacity level of output
101
What is the normal capacity level of output?
The level of output at which productive efficiency is achieved
102
What are the determinants of LRAS the same as?
The determinants of PPF position
103
What are eight determinants of LRAS position?
1. State of technical progress
2. Quantities of capital and labour
3. Mobility of factors of production
4. Productivity of the factors of production
5. People's attitudes to hard work
6. Personal enterprise availability
7. Existence of economic incentives
8. Structure of economy
104
Why do attitudes to hard work influence LRAS?
It reflects how much work people are willing to do. One could discuss full employment as a NORMATIVE CONCEPT
105
What is personal enterprise availability?
Risk-taking entrepreneurs are key to shifting LRAS right
106
Why would communism limit the LRAS?
Existence of appropriate economic incentives
107
What is meant by 'the structure of the economy' as a determinant of LRAS?
For instance, the rule of law and property rights influence entrepreneurship
108
Why is overproduction not sustainable?
Wage costs increase, causing a shift in SRAS backwards
109
Who believes the LRAS curve was not vertical?
Keynes believed there was a long-run state of unemployment that could exist
110
What does effective AD mean?
...
111
Why is credit not readily available in some countries?
In countries like Japan, credit is not culturally normal, leading to frugal investment funded by retained profit.
112
What has Japan experienced due to demand deficiency?
Progressive low growth and deflation.
113
Why is overproduction not sustainable?
Wage costs increase, causing a shift in SRAS backwards.
114
Who believes the LRAS curve was not vertical?
Keynes.
115
What did Keynes believe about unemployment?
He believed there was a long-run state of unemployment created by poor confidence.
116
What does effective AD mean?
AD with the ability to pay to back it up.
117
Why does income flow in a circle?
Because of the exchange of factors of production.
118
Which factor of production is paid for by interest?
Capital.
119
What makes the circular flow model imperfect?
Injections and withdrawals.
120
What are the 3 injections in the circular flow model?
1. Exports (X)
2. Investment (I)
3. Government spending (G)
121
What are the 3 leakages in the circular flow model?
1. Savings (S)
2. Taxes (T)
3. Imports (M)
122
What percentage of AD is consumption?
63%.
123
What happens as price levels rise?
AD contracts.
124
What fundamentally causes a shift in AD?
Changes to consumption (C), investment (I), government spending (G), exports (X), or imports (M).
125
What is the definition of investment?
Spending that increases the capital stock.
126
Is spending on training programs considered investment?
Yes.
127
What is the main source for short-term government spending?
Transfer payments e.g. benefits, salaries, utility bills.
128
Where can government spending go to impact LRAS more than AD?
Capital investment.
129
What is the savings ratio?
S/Y (Saving/Total income).
130
Why is investment so volatile?
Due to the accelerator.
131
What is the basic definition of the accelerator?
When national income rises, investment rises more than proportionately.
132
How can we explain the accelerator effect in terms of the theory of the firm?
There is imperfect information about future demand, firms must be price elastic in supply.
133
Why is investment more volatile than national income?
Due to the accelerator and negative accelerator.
134
What is full employment equilibrium?
When unemployment equals natural rate of unemployment (NRU).
135
How can the exchange rate impact SRAS and AD?
It can increase costs of business, causing a leftward shift in SRAS.
136
What fundamentally causes a shift in SRAS?
Changes in business costs.
137
What does a supply-side shock mean?
Anything that impacts SRAS.
138
Why is the SRAS curve non-linear?
Due to reducing availability of factor inputs.
139
What can LRA growth be broken down into?
1. Productivity change
2. Increased availability of factors.
140
Why is the Keynesian LRAS L-shaped?
1. Increases in output for spare capacity are reflationary, not inflationary.
2. The economy can settle at a long-run equilibrium below Yn.
141
Which components of AD are also injections into the circular flow?
All but consumption.
142
When is the multiplier effect greater in relation to (X-M)?
When a country imports less.
143
How might the Keynesian theory of the MPC be less relevant now?
Due to globalization and the primacy of the marginal propensity to import (MPI).
144
In countries with high debt, what is the multiplier effect?
It is lower, perhaps even negative, affecting macro instability.
145
What are 3 reasons economic growth has not recovered after 2008?
1. Wage growth has not followed.
2. Low base interest rates not fed into lower commercial rates.
3. Confidence damaged.
146
Why are tax breaks best given to the poorest?
1. Equity
2. Marginal propensity to consume (MPC).
147
What do national income, national output, and national expenditure measure?
New output in the economy for a given time period.
148
Why is national output a purer measure of output?
It measures the totals of all goods and services produced by the economy.
149
How is national income measured?
By the value of incomes received by different factors of production.
150
What is national expenditure?
How money is spent on new goods and services produced within the economy.
151
What must be true for national income, national output, and national expenditure to be equal?
No leakages or injections to the circular flow.
152
How does the output approach work?
We measure the value added at each stage of the production process.
153
How is GDP measured by the output approach?
By calculating Gross Value Added (GVA) for industries and aggregating for the whole economy.
154
What is a two-sector economy?
A closed economy with only private firms and consumers (households).
155
In the circular flow of income, what do dashed lines represent?
Real flows of goods or labour supplied.
156
In the circular flow of income, what do solid lines represent?
Money, either consumption spending or income.
157
When does equilibrium national income occur?
When injections equal withdrawals.
158
What is equilibrium income not necessarily the same as?
Full employment equilibrium, as disagreed by neoclassical economists.
159
How can we evaluate the circular flow model's view on savings as a withdrawal?
Banks may use loans as reserve account finance, leading to further investment, an injection.
160
How does low confidence affect the circular flow model?
Savings exceed investment, hence national income falls.
161
What does import spending stimulate?
The economies of foreign countries.
162
How does the Keynesian theory explain recession in the circular flow model?
Investment would not rise to match increased withdrawals when confidence is low.
163
What is the conventional free market view of economic recovery from recession?
1. Demand for money falls.
2. Interest rates fall.
3. Wages fall.
4. Firms expand.
5. This expansion reflates the economy.
164
What are 3 Keynesian criticisms of the conventional free market view?
1. Fractional reserve banking is flawed.
2. Without 'animal spirits', why would investment begin?
3. 'In the long run, we are all dead' - it might work, but not quickly.
165
What is the art in economic modeling?
Making relevant simplifications without oversimplifying economic relationships.
166
Where does much economic debate usually come from?
When different models provide contrasting accounts of future economic outcomes.
167
What are 2 facts about the Phillips machine?
1. Shows the effect of monetary and fiscal policy on the national income model.
2. Can predict economic impact with 4% accuracy.
168
What are reflationary policies?
Policies that increase aggregate demand to boost real output and employment.
169
Why might the slope of an AD curve be exaggerated?
It is sloped down due to substitution to foreign markets.
170
What is aggregate supply?
The level of real national output that producers are prepared to supply at different average price levels.
171
Does the gradient of AD matter?
No.
172
Why is the LRAS positioned as it is?
It represents the resource constraint, showing how much a country could physically produce.
173
What is short-run growth the result of?
AD.
174
Can short-run economic growth occur from an increase in SRAS?
Yes, but it is rare and requires existing supply capacity being unused.
175
What is an example of SRAS driven short-run economic growth?
The Belgian Miracle (1945-1948) - productive infrastructure put to good use.
176
What are 3 terms for productive capacity?
1. Full employment equilibrium
2. Normal capacity
3. Equilibrium national income.
177
What is an example of an economic shock that was both supply and demand-side?
Major wars, e.g., the War in Ukraine.
178
What is the best supply-side economic shock to know?
The Yom Kippur War and subsequent Arab League oil embargo (October 6, 1973).
179
How does El Nino act as both a supply-side and demand-side shock?
In the USA, it boosts GDP by increasing crop output, but raises commodity prices globally.
180
What is a movement along the AD curve?
A change in price level not caused by a change in the components of AD.
181
What is a shift of the AD curve?
A movement of the AD curve in the x-y space.
182
What happens when AD increases?
AD shifts right.
183
What happens during an expansion in AD?
Price levels fall.
184
What is the opportunity cost of consumption?
Saving.
185
What are 2 reasons interest rates affect consumption?
1. Higher interest rates make saving more attractive.
2. Credit becomes more expensive.
186
What is the real rate of interest?
Nominal rate of interest minus current inflation rate.
187
What is the paradox of thrift?
Where saving, as a net withdrawal from the circular flow, has deflationary impacts.
188
What is the life-cycle theory of consumption?
A theory explaining consumption and saving based on expected income changes over a lifetime.
189
How does life-cycle theory differ from Keynesian absolute income theory?
Absolute-income theory focuses on current income, while life-cycle theory considers long-term expectations.
190
What is an example of life-cycle theory of consumption?
People dedicate a fixed amount to their private pension each year, unaffected by annual economic fluctuations.
191
What are 3 reasons house prices are linked to consumption?
1. Positive wealth effect.
2. Decreased need for saving due to liquidated assets.
3. Easier access to loans using property as collateral.
192
What is equity?
The difference between asset price and the loan used to buy it.
193
What is the wealth effect?
Spending linked to asset prices and perceived wealth.
194
What is a mortgage equity withdrawal?
Borrowing secured on the house but not invested in it, used when house prices rise.
195
Do asset prices always link to the wealth effect?
No, it depends on whether economic misery is foreseeable.
196
What is a main determinant of consumer confidence?
The perceived security of government economic policy.
197
What is an example of how interest rates aren't the only determinant of consumption?
Availability of credit, e.g., post-2007 credit crunch.
198
What kind of consumption occurs when inflation is rumored?
Asset consumption.
199
What are the determinants of saving?
The same as the determinants of consumption.
200
What are personal and household savings ratios good indicators of?
Future consumption and economic growth in the short run.
201
What did the savings ratio reach during the pandemic?
Over 20% due to uncertainty and consumption bans.
202
What was the previous UK savings ratio?
7-10% for much of 2012-2016, fell below 5% from 2016 onwards.
203
What effect did unconventional monetary policy have on Japan's savings ratio?
Savings ratio remained high despite 0% interest rates, debunking Keynesian theory.
204
What are savings ratios most linked to?
Confidence in the future.
205
What was a negative aspect of the Financial Crisis?
The ORIGINATE AND SELL model led to interdependence and moral hazard.
206
Why did house prices fall after the recession?
Demand for housing stock fell due to reduced credit availability.
207
What is a sub-prime mortgage?
A mortgage taken out by a borrower with a poor credit rating.
208
How can investment spending be greater than 0 with no economic growth?
Through replacement investment.
209
How do firms make investment decisions?
By estimating future revenues and costs, considering inflation.
210
Why is there a relationship between factor prices and productivity?
Firms buy the cheapest factors with the highest productivity.
211
What does quick technical progress imply for capital goods?
Their business life is shorter than their technical life.
212
Why might the government make poor investment decisions?
Different incentives, such as lack of bankruptcy threat.
213
What is the accelerator?
Change in the level of investment in new capital goods induced by a change in national income.
214
What is the inverse of the accelerator?
Say's Law.
215
What are 2 facts underlying the accelerator effect?
1. Firms wish to keep a fixed capital-output ratio.
2. Firms must pay for capital consumption.
216
Why is the accelerator called an accelerator?
Because the capital-output ratio is greater than 1.
217
What makes investment a volatile component of AD?
The accelerator effect due to capital-output ratios.
218
What determines the size of the accelerator?
The capital-output ratio.
219
What happens when AD shifts?
1. Economic activity changes to produce a different level of real output.
2. Cyclical unemployment may vary.
220
What determines how much output versus price level will change for a given increase/decrease in AD?
The shape of the SRAS curve.
221
What is the multiplier?
The relationship between a change in a component of AD and the resultant change in national income.
222
How does the multiplier work?
Any initial change in spending is subsequently spent repeatedly through the economy.
223
What happens when AD shifts?
1. Economic activity changes to produce a different level of real output
2. Cyclical unemployment may vary
224
What determines how much output versus price level will change for a given increase/decrease in AD?
Shape of SRAS curve
225
What is the multiplier?
Relationship between a change in a component of AD and the resultant, generally greater, change in national income
226
How does the multiplier work?
Any initial change in spending is subsequently spent repeatedly through the economy
227
Why can the multiplier create problems for governments?
1. MPC and MPS fluctuate depending on consumer confidence
2. Can create output gaps if the government misjudges
228
What has a multiplier?
Anything which represents an injection or a withdrawal
229
What are the 6 multipliers?
1. G multiplier
2. T multiplier
3. M multiplier
4. X multiplier
5. I multiplier
6. National income multiplier (any of the above)
230
What are tax and import multipliers?
Always negative since both tax and imports are withdrawals from the circular flow of income
231
Example of a regional multiplier?
How much of a stimulus in Cornwall is actually spent in Cornwall?
232
Why is the multiplier for the UK small despite low personal and household savings ratios?
High leakage to taxes and imports
233
Hypothetically, if SRAS is vertical, what is the multiplier of any injection?
0
## Footnote
100% deflected into rising price level
234
Why is AD linked to cyclical employment?
Labour is in derived demand
235
What are 3 examples of production costs which might shift SRAS?
1. Taxes across the economy
2. Money wage rates
3. Productivity
236
Is YFE 'full employment'?
Depends on your definition of full employment - very unlikely to be literally 100% of workers employed, but likely to exclude only those who are structurally unemployed
237
What is the normal capacity level of output?
The level of output at which the full production potential of the economy is being used
238
Example of how 'the structure of the economy' can be a determinant of LRAS?
Credit crunch and the inability of banks to provide credit
239
Why are positive output gaps not sustainable?
Causes rising business costs through higher wages (cost push inflation) and hence shifts SRAS left to resolve the positive output gap
240
When drawing AD/AS diagrams with reference to inflation, what might it be good to do and why?
Use Pdot on the y-axis since we rarely actually see deflation
241
What is the current bank rate and as of when?
8th May 2025 - cut to 4.25%, a quarter-point cut
242
How is AD a measure of GDP?
National expenditure approach
243
True or false: AD is a measure of the Q produced in an economy in a year.
FALSE - measure of total planned spending
244
What does the negative slope of the AD imply?
There is an inverse relationship between the PRICE LEVEL and REAL GDP
245
What are 3 reasons AD slopes down?
1. Wealth effect
2. Trade effect
3. Interest effect
246
What is the wealth effect?
Affect consumption. People are richer in real terms because they can afford more. So there will be an extension in AD
247
What is an extension/contraction in AD?
A change in real GDP ONLY caused by a change in the price level
248
What is the trade effect?
Affect (X-M). The price competitivity of exports
249
What is the interest effect?
At a low price level, central banks are likely to have cut their interest rates, since the risk of inflation is low. We know that low interest rates stimulate consumption, investment and reduces the exchange rate. Affect C, I and (X-M)
250
What does AD shift due to?
C+I+G+(X-M) but NOT TO DO AT ALL WITH CHANGES IN THE PRICE LEVEL
251
Whenever AD shifts...
The multiplier can kick in
252
How can tax rates affect consumption?
A cut in taxes leads to a rise in real disposable income and hence consumption
253
Why can home ownership make C as a component of AD particularly prone to fluctuations of IR?
Mortgages OFTEN IN THE UK are variable rate or tracker rate mortgages. A change in the base rate therefore changes monthly income spent on mortgage interest payments
254
Example of how interest rates being low might be precluded by a lack of availability of credit?
Post-recession - IR lowest on record but credit hard to attain
255
When consumer confidence is higher...
MARGINAL PROPENSITY TO CONSUME IS HIGHER
256
What are 2 examples of consumer confidence?
1. Job prospects
2. Level of unemployment
257
Why can levels of unemployment and job prospects affect consumption?
People are more liable to consume if they feel that jobs are available
258
What is the negative equity trap?
When falling asset prices means you are stuck with an asset and cannot liquidate it
259
Example of how being overleveraged can affect consumption?
Recession - too much private debt led to consumption crunch
260
What does overleveraged mean?
When a FIRM has taken on too many liabilities
261
What is saving?
Income not used for consumption
262
Is saving a determinant of AD?
Indirectly, since higher saving implies consumption is lower
263
What are 6 determinants of how much saving goes on?
1. Level of real disposable income - higher and more saving, lower and immediate consumption demands preclude saving
2. Interest rates
3. Consumer confidence
4. Security of financial sector
5. Tax incentives
6. Age structure of population
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Example of a tax incentive which encouraged saving?
ISAs
265
How is real disposable income a determinant of saving?
More income -> more saving, logically
266
How is an interest rate a determinant of saving?
Opportunity cost of consumption rises due to high rate of return on savings
267
What is the effect of low consumer confidence on savings?
Causes them to build up as consumers develop resilience to a downturn
268
When is a low level of integrity/trust in financial institutions a particularly powerful determinant of savings?
In developing countries
1. Corruption
2. Education about banking
Or in countries where financial regulation is less
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What is an ISA?
A savings account where you don't pay tax up to a certain point. Introduced by New Labour 1999. As of 2025 is under review for whether this is still affordable.
270
Who is Franco Modigliani?
Italian economist responsible for the idea that demographics are linked to savings. Middle aged likely to save more and younger/older likely to spend. LIFE-CYCLE THEORY OF CONSUMPTION AND RATIONAL EXPECTATIONS
271
What are 3 other determinants of investment?
1. Level of competition
2. Corporation tax rates (AFFECTS ABNORMAL PROFIT MARGINS)
3. Spare capacity at current output
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What is investment?
When firms spend money on capital goods to increase their productivity
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Why is business confidence lower in a recession?
No optimism of demand, so no guarantee of rate of return, so investment demand falls
274
What is the hurdle and eval?
The minimum rate of return for which an investment project is justifiable
## Footnote
If firms don't expect to make this rate then they won't invest.
275
What is the effect of interest rates on the hurdle?
When interest rates are lower, it is easier to reach that hurdle rate
276
Why does a predicted recession lower investment?
Expectations of lower demand mean that derived demand for investment falls
277
How can corporation tax reduce investment?
Less RETAINED PROFIT (after corporation tax) with which to spend on investment. We know RP is the main source of investment
278
How can spare capacity affect MPI?
Lower MPI when spare capacity exists - just expand to fill this capacity
279
How can competition affect investment and eval?
Generally, investment is proportional to competition, but occasionally imperfectly competitive markets invest more because they have more retained profit
280
Is G short-run or long-run growth?
Depends. Usually short-run in the sense that it stimulates AD and then latterly long-run by developing infrastructure through investment
281
What are the 4 types of government spending?
1. CURRENT SPENDING - paying public sector wages, maintenance of public sector industries etc.
2. Capital spending - spending on infrastructure etc.
3. Welfare spending - BIGGEST COMPONENT of G - transfer payments
4. Debt interest payments - on the rise
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Is debt interest an injection?
NO - this will not increase AD
283
What is evidence that debt spending in the UK is expensive?
Around 50bn per year, versus 90bn on education
284
What is the fiscal year?
1st April - 1st April
285
What does G > T indicate?
Budget deficit
286
What does T > G indicate?
Budget surplus
287
What are 5 things which can determine export demand?
1. Real disposable income of foreigners
2. Real disposable income of domestic consumers
3. Strong or weak exchange rates
4. Protectionism at home or abroad
5. Relative inflation at home
288
True or false: a rise in the number of goods bought by households implies a shift right of AD.
NO - needs to be EXPENDITURE increasing, not volume
289
How can a recession in a major trading partner reduce AD?
Fall in disposable incomes -> fall in spending on exports
## Footnote
UNLESS UK EXPORTS ARE INFERIOR GOODS
290
Under what circumstances can AD shift left when real disposable incomes of domestic consumers rises?
We demand more imports hence weakening (X-M)
## Footnote
MPI rises when incomes rise because UK consumers see foreign goods as luxury goods (often more expensive)
291
What are 2 mnemonics for exchange rates and AD?
1. WIDEC
2. SPICED
292
How can a strong exchange rate impact AD?
SPICED - AD shifts left
293
How does China use its exchange rate to support AD?
WIDEC - keep export low to make Chinese exports price competitive, even if they don't have comparative advantage
294
Why is relative inflation levels domestically important to export demand?
When domestic inflation is HIGHER than foreign inflation, then exports are less price competitive, reduces exports expenditure, ceteris paribus
## Footnote
When domestic inflation is LOWER than foreign inflation, exports are more price competitive, meaning UK exports are more price competitive, increasing export expenditure, ceteris paribus
295
Is there SRAS in the Keynesian model?
NO
296
What determines SRAS?
Short-run costs of production
297
What is an important single determinant of SRAS?
Oil prices - used in many products and much oil is domestically produced
298
What shifts SRAS?
Supply-side shock
299
What is Yfe?
The full employment level of real national output at a sustainable level
300
Can output be higher than LRAS?
Yes, but THIS IS NOT SUSTAINABLE IN THE LONG-RUN
301
What is the NRU figure?
Actually about 4.5%
302
What is the fundamental determinant of LRAS?
Q^2CELL and productive efficiency
## Footnote
Quantity and quality of capital, enterprise, labour and land
303
How can competition affect LRAS?
Generally speaking, improves LRAS because firms face more competition
304
How can hysteresis affect LRAS?
Decrease quantity of labour seen as appropriate and reduce productivity of existing labour
305
What are the determinants of Keynesian LRAS?
Same as neoclassical LRAS
306
Why is the LRAS non-linear for Keynesians?
There is spare capacity
307
When is macroeconomic equilibrium achieved?
AD = AS
308
What is the key difference in views of macroeconomic equilibrium between Keynesian and neoclassical economists?
Neoclassical economists believe SRAS can = AD without = LRAS, but Keynesians believe that necessarily, because LRAS is non-linear, that AD===AS
309
What does Y > YFE indicate?
Unsustainable use of factors of production is going on - SHORT-RUN - NOT SUSTAINABLE
310
According to classical economists, is SRAS = AD at below Yn sustainable?
No, this negative output gap will not persist
311
Is there YFE on a Keynesian LRAS?
Yes
312
What are 4 things which happen when AD shifts right?
1. GROWTH INCREASES
2. UNEMPLOYMENT FALLS
3. INFLATION INCREASES
4. TRADE POSITION WORSENS
313
Why does AD shifting right increase growth?
1. Increased demand for goods and services
2. Firms increase supply
3. Real output increases
314
Explain why growth can reduce unemployment?
Unemployment reduces because labour is in derived demand for the output produced
315
Why does demand-pull inflation occur?
Increasing factor scarcity
316
Why does AD shifting right tend to worsen the trade position?
1. Inflation worsens export competitiveness
2. Imports become more demanded in countries with high MPIs
317
What effect does LRAS shifting right have on the trade position?
Lower inflation
318
Why does inflation reduce when LRAS shifts right?
Reduced COMPETITION for scarce factors of production
319
What is k?
1/MPW
320
Why is k = 1/MPW better than 1/MPS?
Leakages not just saving
321
What can affect the multiplier?
1. Significance of crowding out
2. Taxation
3. Import expenditure
## Footnote
ALL WITHDRAWALS
322
How does the multiplier/accelerator interaction work?
1. Injection into circular flow
2. Multiplier causes a more than proportionate increase in final national income
3. Firms respond to higher rate of expected real national output by investing to keep their capital:output ratio constant (accelerator effect)
4. HOWEVER both effects subsequently dry up
5. Downturn and firms liquidate stock
323
When GDP growth slows, what happens to the accelerator?
Goes negative, accentuating the decline in real GDP, as firms lose confidence on rate of return and stop investment
324
What is a negative output gap?
Actual level of real national output is less than potential output
325
How to illustrate when supply-side policies would be useless?
KEYNESIAN AD/AS - AD ON FLAT BIT AND LRAS SHIFTING RIGHT HENCE HAS NO IMPACT
326
What is actual growth?
Another name for short-run growth caused by AD shifting right
327
When you use a PPF to show short-run growth, what are your axes labelled?
Goods and services (two things the economy can produce)
328
What are the basic 3 effects of lowering the interest rate?
1. More consumption - reduced incentive to save and cheaper to borrow
2. Increased investment - reduced cost of borrowing and increased consumption, accelerator
3. Net exports increase - currency depreciates because hot money flows leave, making exports more competitive
329
What is potential growth?
LRAS shifts right
330
Does LRAS shifting right imply actual growth?
No - just that we have the capacity available for growth
331
What are 3 reasons for the LRAS shifting right?
1. Quantity of factors
2. Quality of factors
3. Productive efficiency of factors
332
What is another name for the economic cycle?
Business cycle
333
What is a key indicator of a recovery beginning?
House prices begin to rise again
334
What are 4 benefits of growth?
1. Incomes increase
2. Employment increases
3. Profits increase
4. Fiscal dividend for government
335
What are 3 ways tax revenues rise in the upturn?
1. Tariff revenues
2. Indirect tax revenues
3. Direct tax revenues
336
What are 4 costs of growth?
1. Inflation
2. Income inequality
3. Environmental costs
4. Current account deficit
337
What are 3 reasons growth can worsen income inequality?
338
Key indicator of a recovery beginning?
House prices begin to rise again
339
4 benefits of growth
1. Incomes increase
2. Employment increases
3. Profits increase
4. Fiscal dividend for government
340
3 ways tax revenues rise in the upturn?
1. Tariff revenues
2. Indirect tax revenues
3. Direct tax revenues
341
4 costs of growth
1. Inflation
2. Income inequality
3. Environmental costs
4. Current account deficit
342
3 reasons growth can worsen income inequality?
1. Sector-led e.g. financial sector and UK growth
2. Rural vs urban
3. Capital intensive - owners of capital gain
343
What conflict of macro objectives exists between growth and the current account of the BOP?
Higher growth -> higher imports -> worsening current account deficit. Particularly bad in the UK with high MPI
344
4 ways we could evaluate growth in an exam?
1. Sustainable growth, without externalities or resource degradation
2. Inclusive growth, with inequality managed
3. Balanced growth, with inequality between sectors managed, and balanced so that AD doesn't become too dependent on one sector, which could leave us exposed
4. Role for private sector and government should be balanced, so supply-side doesn't atrophy
345
Definition of unemployed
Of a working age (16-64), being willing to work, being able to work, seeking a job, but not in a job
346
Unemployment rate formula
(Unemployed / Economically active) x 100
347
Main reason claimant count as a method of comparison is poor?
Difficult to compare between countries because different countries have different benefit systems
348
3 problems with LFS?
1. +/-3% error, and also keep in mind that the sample size is small (40,000 HHs, 100,000 ppl, fell to 15,000 recently)
2. Hidden unemployment - people counted as inactive who may be better categorised as unemployed
3. Under-employment
349
Evidence under-employment is a problem with LFS?
You only have to work 1 hour a week to be counted in LFS
350
2 main types of unemployment?
1. Disequilibrium unemployment
2. Equilibrium unemployment (NRU)
351
2 types of disequilibrium unemployment?
1. Cyclical unemployment
2. Real wage unemployment
352
Why is cyclical unemployment particularly likely?
Biggest cost of production for most firms is labour
353
Sticky wages? Who is associated with this theory?
Nominal wages slow to fall when derived demand for labour falls. So when demand for labour falls as a result of a recession, this can create more cyclical unemployment than lower wage rates. KEYNESIANS - it is a Keynesian theory of cyclical unemployment
354
2 examples of why real wage unemployment may occur?
1. Trade unions
2. Minimum wage
355
3 types of equilibrium unemployment?
THE NATURAL RATE OF UNEMPLOYMENT - Beveridge definition
1. Structural unemployment
2. Frictional unemployment
3. Seasonal unemployment
356
Reason for structural unemployment
IMMOBILITY OF LABOUR
357
Definition of structural unemployment
The immobility of labour due to a long term change in the structure of an industry
358
2 types of labour mobility?
1. Occupational
2. Geographical
359
3 routes to structural unemployment?
1. Technology advancements
2. Loss of comparative advantage
3. Creative destruction
360
Example of an industry that, via a technology advancement, experienced structural unemployment?
Banks and end of retail banking branches
361
NRU
The unemployment that occurs even when the labour market is in equilibrium
362
3 components of NRU?
1. Structural
2. Frictional
3. Seasonal
363
2 free market arguments for NRU unemployment?
1. Generous benefits system encourages structural unemployment
2. Excessive regulation increases occupational and geographic immobility of labour
364
2 interventionist arguments for NRU unemployment?
1. Lack of transport/housing infrastructure
2. Lack of in-work training
365
Example of how regulation of the labour market could increase NRU?
In the US, firing regulations are pretty lax. This can increase employment because firms know that the worker can easily be fired if their MRPL is discovered to be too low. In France, regulation is higher, reducing this possibility
366
How can the government not intervening to provide transport/housing infrastructure increase NRU?
Reduce mobility of labour
367
Definition of the SR/LR for the AD/AS model revolve around...
When costs for factors of production including wages are variable
368
For the classical AD/AS economy, in the LR...
The full employment equilibrium will always be achieved
369
How can we show the automatic equilibrium achieved in the classical AD/AS diagram?
DIAGRAMS WHERE WE READJUST TO AD=LRAS
370
The classical AD/AS model presumes that, when AD shifts left...
A new full employment equilibrium is automatically selected by cutting business costs to remain competitive at the lower price level. BUT STICKY WAGES!
371
Why do neoclassical economists say negative output gaps persist? However?
Reluctance of economic agents to accept cost-cutting measures necessary e.g. cutting wages. IN THE LONG RUN, the belief is that workers revise down their wage expectations in light of the negative output gap, and the economy can return to full employment at Yn.
372
Why do neoclassical economists believe that a positive output gap is unsustainable?
In the long run, SRAS shifts left again as workers realise their bargaining power from their increasing derived demand and bargain for higher wages
